- Category: Judge Nugent
- Published on 03 December 2013
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Disc Heat, LLC v. Kansas Department of Revenue, 13-05069 (Bankr. D. Kan. Nov. 19, 2013) Doc. # 17
SIGNED this 18th day of November, 2013.
NOT DESIGNATED FOR ONLINE OR PRINT PUBLICATION
IN THE UNITED STATES BANKRUPTCY COURT
FOR THE DISTRICT OF KANSAS
IN RE: )
DISC HEAT, LLC, ) Case No. 13-10568
) Chapter 11
DISC HEAT, LLC, )
vs. ) Adversary No. 13-5069
KANSAS DEPARTMENT OF REVENUE, )
ALCOHOLIC BEVERAGE CONTROL, )
ORDER GRANTING DEFENDANT’S MOTION TO DISMISS
The State of Kansas cannot issue a liquor license to anyone who intends to carry
Case 13-05069 Doc# 17 Filed 11/18/13 Page 1 of 5
on the business “as agent of another.”1 According to the State, when the debtor in this
case, Disc Heat, LLC, renewed its license in 2009 and again in 2010, it acted as the
agent of Edem Banda, its principal. The State contends that at both times, another
person owned 100 percent of the LLC, and that Disc Heat did not disclose that
ownership interest. When the State discovered this, it revoked Disc Heat’s license. Disc
Heat pursued an administrative appeal of the revocation and, when that failed, sought
state court judicial review. While that review was pending, Disc Heat filed this chapter
11 bankruptcy case and adversary proceeding, seeking this Court’s order enjoining the
revocation under 11 U.S.C. § 105(a), even though a governmental entity’s exercise of
its police powers is expressly excepted from the automatic stay by § 362(b)(4). The
State moved to dismiss Disc Heat’s adversary proceeding, alleging a spectrum of
grounds ranging from failure to sue the appropriate entity to Eleventh Amendment
sovereign immunity.2 Disc Heat failed to respond to the motion. I conclude that it
should be granted.3
Disc Heat operates the Suede piano bar and lounge in downtown Wichita.
Taking the allegations of its complaint as true, Suede needs its liquor license to
successfully reorganize its affairs. In its complaint and in preliminary injunction
KAN. STAT. ANN. § 41-311(a)(8) (2012 Supp.). See also § 41-2623(a)(1) (2012 Supp.).
Adv. Dkt. 8 and 9. The movant Kansas Department of Revenue appears by
Assistant Kansas Attorney General Derenda J. Mitchell. The debtor Disc Heat was
represented by Nicholas J. Grillot in this adversary proceeding.
Disc Heat has filed no objection or other form of response to the State’s motion. D.
Kan. Rule 7.4(b) applies to motions filed in this Court and provides that if the nonmoving
party fails to respond, “the court will consider and decide the motion as an
Case 13-05069 Doc# 17 Filed 11/18/13 Page 2 of 5
proceedings before the Court, Disc Heat has argued that this fact is a sufficient basis
for enjoining the State from prosecuting the license revocation proceedings under the
general powers conferred on bankruptcy courts by § 105(a). That section allows the
court to issue orders that are “necessary or appropriate” to carry out the provisions of
Title 11. Disc Heat essentially asserts that its retention of the license is necessary to
its effective reorganization and that the bankruptcy court has power to facilitate that
retention even though police power actions by the State are clearly excepted from the
§ 362 stay.4
Assuming that a federal court can ever have jurisdiction to thwart the state law
regulatory process as Disc Heat asks in its complaint, the debtor should at least sue
the proper party. The sole named defendant in this case is the “Kansas Department of
Revenue, Alcoholic Beverage Control.” The KDR is a subordinate government agency
that cannot sue or be sued by itself -- nothing in the statutes grants it that capacity.5
Like any other subordinate state agency, it may only be sued in conjunction with the
State of Kansas.6 Likewise, there is no statutory authority granting the ABC, a division
See § 362(b)(4) (excepting from the stay “the commencement or continuation of anaction or proceeding by a governmental unit or any organization . . . to enforce suchgovernmental unit's or organization's police and regulatory power . . . .”).
Hopkins v. State, 237 Kan. 601, 606, 702 P.2d 311 (1985) (interpreting the KansasTort Claims Act, noting that a subordinate government agency lacks capacity to sueor be sued absent statutory authority; Kansas highway patrol did not have capacityto be sued, KAN. STAT. ANN. § 74-2105 et seq.).
See KAN. STAT. ANN. § 75-6102(a) (2012 Supp.); see also Mid American Credit
Union v. Board of County Com’rs, 15 Kan. App. 2d 216, 224, 806 P.2d 479 (1991)
(state and Department of Revenue may be sued together, but KDR may not be suedalone).
Case 13-05069 Doc# 17 Filed 11/18/13 Page 3 of 5
of the KDR, the capacity to sue and be sued.7 Thus, Disc Heat has failed to properly
invoke such jurisdiction as this Court may have. That alone is grounds for dismissal.
And even if Disc Heat had sued the proper party or parties, the relief it seeks
is simply not available here. Contrary to its Disc Heat’s legal claims, a Kansas liquor
license is not a property interest. KAN. STAT. ANN. § 41-326 states that a license “shall
be purely a personal privilege . . and shall not constitute property.”8 Nor can a license
be encumbered or transferred. Only upon a court order can a liquor license descend
under the probate laws. Because the transfer of a license is either prohibited or heavily
conditioned, it is not a source of value that can be distributed to Disc Heat’s creditors,
even though it is crucial to the ongoing operation of Disc Heat’s bar. We distinguish
this case from Bogus v. American National Bank, a Tenth Circuit case involving a
bankruptcy trustee’s attempt to avoid a lien in a Wyoming liquor license that the
debtor granted outside the preference period, but assigned and surrendered to the
bank for sale within the period.9 Applicable Wyoming state law permitted the
assignment and transfer of liquor licenses under certain conditions and expressly
permitted one to be assigned as collateral.10 The Kansas liquor laws expressly prohibit
that. A § 105(a) injunction would be of little benefit to the creditors of Disc Heat nor
See KAN. STAT. ANN. § 75-5117 (2012 Supp.) and KAN. ADMIN. REG. § 14-16-14 et
seq and § 14-21-1 et seq (2013)
KAN. STAT. ANN.
§ 41-326 (2012 Supp.).
Bogus v. Am. Nat. Bank, 401 F.2d 458, 459 (10th Cir. 1968)
Id. at 459-61.
Case 13-05069 Doc# 17 Filed 11/18/13 Page 4 of 5
would it “carry out the provisions of this title” which expressly except police power
actions of the type debtor seeks to enjoin from the scope of the automatic stay.
Having fully considered the legal arguments advanced by the State in its motion,
I conclude that it should be granted for the reasons stated therein and the reasons
discussed above. This adversary proceeding should be DISMISSED. A judgment on
decision shall issue this day.
# # #
Case 13-05069 Doc# 17 Filed 11/18/13 Page 5 of 5
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- Published on 08 October 2013
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12-11246 Roy (Bankr. D. Kan. Sep. 24, 2013) Doc. # 39
SIGNED this 24th day of September, 2013.
NOT DESIGNATED FOR ONLINE OR PRINT PUBLICATION
IN THE UNITED STATES BANKRUPTCY COURT
FOR THE DISTRICT OF KANSAS
JEREMY JOSEPH ROY,
AMY SUE ROY,
Case No. 12-11246
ORDER ON TRUSTEE’S MOTION FOR TURNOVER
The “right to receive” an earned income tax credit under § 32 of the Internal
Revenue Code or KAN. STAT. ANN. § 79-32,205 (2012 Supp.) was declared exempt for
Kansas bankruptcy debtors with the enactment of KAN. STAT. ANN. § 60-2315 (2012
Supp.) in 2011. This seemingly straightforward exemption provision, enacted to
preserve this tax attribute for the benefit of low income, working people with children
or other dependents, has drawn numerous challenges on multifaceted grounds from
Case 12-11246 Doc# 39 Filed 09/24/13 Page 1 of 19
chapter 7 trustees in this District. Unlike the cases in which the trustees have
mounted constitutional challenges to the Kansas exemption statute, the trustee in this
case seeks to limit the exemption by requiring the debtors to apply some of it to their
prepetition tax liability. But because the statute expressly exempts the debtors’ right
to receive the credit “not to exceed” its maximum amount, and because Kansas law has
long prohibited creditors from marshaling a debtor’s assets in ways that would impair
the debtor’s exemptions, this part of the trustee’s motion for turnover must be denied.
The trustee’s other two concerns, whether the debtors’ attorney’s fee assignment
should be prorated between the federal and state income tax refunds, and whether the
trustee can recover the $5.45 remaining in the debtors’ bank account on the petition
date are resolved as follows. There is no reason why an attorney’s form of assignment
cannot specify from which refund his or her fees will be collected. When the assignment
doesn’t specify, however, prorating the assigned fee between the two refunds is
workable and makes sense. As to the aggregation of small assets, in this case $5.45 is
simply not an economically feasible amount of money to recover in the face of any
material resistance and should be abandoned. The balance of the trustee’s motion for
turnover must therefore be denied.1
The Roys filed this case on May 14, 2012. Their 2012 federal and state income
tax returns indicate that they’re entitled to receive a federal refund of $5,205 and a
1 Dkt. 26.
Case 12-11246 Doc# 39 Filed 09/24/13 Page 2 of 19
state refund of $369. Their federal earned income credit (EIC) amounted to $1,600 and
their state EIC $288. They readily agreed to hand over to the trustee the estate’s share
of their refunds, 135/366 or 36.88525% of their refunds, after reducing the full federal
refund by the $181 attorney’s fee assignment and after deducting the entire amount
of their EIC. The trustee, however, demands not only that the debtors prorate their
attorney’s fee assignment between the federal and state refunds, but also that their
EIC be reduced to bear its proportionate “burden” of both the fees and any federal or
state income tax the debtors owed. These debtors owed no federal tax, but owed state
tax of $890.
We begin with the adjustment upon which all parties (including the Court)
agree. The Roys filed this case on the 135th day of 2012; accordingly, 135/366 or
36.88525% of the refunds, after deduction of attorney’s fees, is property of the estate.2
The debtors’ methodology is the simplest and, therefore, a good place to begin. The
Roys received a federal refund of $5,205. They deducted their lawyer’s $181 fee
assignment and all of their $1,600 EIC, leaving $3,424. Of that amount, 36.88525% is
property of the estate, or $1,262.95. They received a state refund of $369 from which
they deducted their EIC of $288, leaving $81. The estate’s share of that is $29.88.
Table 1: Debtors’ Calculations
Federal Refund State Refund
Refund $5,205.00 $369.00
2 See In re Barowsky, 946 F.2d 1516 (10th Cir. 1991).
Case 12-11246 Doc# 39 Filed 09/24/13 Page 3 of 19
Assignment $(181.00) $0.00
EIC $(1,600.00) $(288.00)
Net Refund $3,424.00 $81.00
Due to Estate $1,262.95 $29.88
The trustee’s calculations are more intricate. First, he would allocate the
debtors’ attorney fee assignment between the federal and state refunds. The debtors’
total refund being $5,574, the federal portion makes up 93.4% of the total and the state
portion makes up 6.6%. The trustee then allocates the fee secured by the assignment,
$181, proportionately, deducting $169.02 from the federal refund and $11.98 from the
state refund. This leaves $5,035.98 of the federal refund and $857.02 of the state
refund for further adjustment.
Then the trustee suggests that the proportion of the EIC to the gross amount of
the refund on each return be determined so that the amount of tax “paid” by the credit
can be determined. What remains after deducting that pro rata payment is, according
to the trustee, the extent of the debtors’ EIC exemption. The debtors’ contrary view is
that after the attorneys fees are deducted, and after the entire EIC amount is
subtracted from that remainder, 135/366 or 36.88525% of what is left is property of the
The trustee’s proposed calculations are below.
Table 2: Trustee’s Calculations--Federal
S Federal Refund $5,205.00
T Fee Assignment $(169.02)
Case 12-11246 Doc# 39 Filed 09/24/13 Page 4 of 19
U Refund net of fee assignment $5,035.98
V Federal EIC $1,600.00
W Proportion of EIC to gross refund 30.74%
X Exemptable portion of EIC [U x W] $1,548.04
Y Net federal refund [U - X] $3,487.94
Z Estate portion [Y x 36.88525%] $1,286.53
So as to the federal refund, the trustee would reduce the exemption by about $52
and increase the estate’s share of the refund by some $23. This effectively requires the
EIC to bear a portion of the debtor’s attorneys fee assignment, but because the debtor
owed no federal income tax, the trustee would not reduce the debtor’s share of the EIC
The trustee’s treatment of the debtor’s state tax refund is significantly different
because the debtor did owe state income tax and was entitled to other, non-refundable
credits. Thus, the trustee allocates some portion of the refundable state EIC to the
payment of state income tax, limiting the amount of the EIC that these debtors would
be permitted to retain as exempt. That calculation is as follows:
Table 3: Trustee’s Calculations--State
R State refund $ 369.00
S Total state credits $ 1,259.00
T Fee assignment $ 11.98
U Refund net of fee $ 357.02
V State EIC $ 288.00
W Proportion of EIC to total credits 22.88%
Case 12-11246 Doc# 39 Filed 09/24/13 Page 5 of 19
X Exemptable portion of EIC [U x W] $ 81.69
Y Net state refund [U - X] $ 275.33
Z Estate’s portion [Y x 36.88525%] $ 101.56
Summarizing the above, the trustee believes the estate is entitled to $1,286.53
of the federal refund and $101.56 of the state refund, while the debtors say they are
only obligated to pay $1,262.95 and $29.88 respectively.
The trustee also contends that the estate should receive turnover of the $5.45
remaining in the debtors’ bank account on the date of filing while the debtors argue
that this amount is burdensome to administer and should be abandoned. There is no
dispute that the balance in the debtor’s bank account on the petition date was $5.45.
Some might be tempted to dismiss the controversies raised here as too petty to
dignify serious consideration, but while the numbers are small, the issues are not.
Giving appropriate effect to the benevolent purposes of the earned income tax credit
and the state’s exemption, both of which were intended to benefit working families who
earn less than $60,000 a year, approximately $12,000 below the median income of a
Kansas family of four,4 is vital to one of the core purposes of bankruptcy courts – to
provide debtors a fresh start in their post-bankruptcy lives.
3 A motion for turnover of property of the estate is a core proceeding under 28
U.S.C. § 157(b)(2)(E) over which this Court has subject matter jurisdiction under 28
U.S.C. § 157(b)(1) and §1334.
4 http://www.justice.gov/ust/eo/bapcpa/20130501/meanstesting.htm, viewed
August 19, 2013.
Case 12-11246 Doc# 39 Filed 09/24/13 Page 6 of 19
The Attorney’s Fee Assignment Adjustment
In a prior set of cases, I have held that when debtors validly assign a portion of
their tax refunds to their attorneys for fees incurred in filing their cases in this
division, the assigned amount should be deducted before the familiar proportional pre-
and postpetition allocation is made under the Barowsky case.5 This case poses the
novel question whether the attorney’s fee should be prorated between the two refunds
(state and federal). Neither party provided any case law to support their positions and
my independent review yields none, leading me to conclude that the practicalities of
this question have either prevented its being presented to other courts or if it has been,
the matter has been decided from the bench. There is nothing inherently objectionable
about requiring debtors to allocate fee assignments between the gross cash amounts
the debtors receive on account of their state and federal refunds, particularly when the
assignment is silent with respect to apportioning the fees among those refunds and the
assignment is of the debtors’ “income tax refunds.”6 The Court will allocate the $181
5 In re Barowsky, 946 F.2d 1516 (10th Cir. 1991) (that portion of income tax
refund attributable to the prepetition portion of taxable year is property of theestate); See Redmond v. Carson (In re Carson), 374 B.R. 247 (10th Cir. BAP 2007)
(an assigned flat-fee retainer may be deducted from the entire tax refund before thepre- and post-petition allocation of the tax refund.); In re Hunter, 2011 WL 1749933
(Bankr. D. Kan. May 5, 2011) (Debtors’ assignment of prepetition portion of incometax refunds to their bankruptcy attorney as a flat fee retainer for filing theirchapter 7 case is enforceable and results in attorney’s fees being deducted from theestate’s prorated share of the refund and not enforced from the post-petition portionof the refund.).
6 Ex. 2. Emphasis added. Cf. Hunter, supra at note 4, where the assignment
was expressly limited to the prepetition portion, or the estate’s share, of the taxrefund.
Case 12-11246 Doc# 39 Filed 09/24/13 Page 7 of 19
attorney’s fee between the federal refund and state refund as advocated by the trustee.
Burdening the Earned Income Credit
As with the attorney’s fee apportionment issue, there are no cases that directly
address the trustee’s argument that when the debtors owe tax to which the EIC would
be applied, the portion of the debtors’ refund that can be attributed to the credit should
be reduced to force the pro rata application of a portion of the credit to the tax paid.
The trustee’s view is that permitting the debtors to retain all of their EIC when, in fact,
some portion of the taxes they pay should be attributed to it effectively places the
burden of paying the debtors’ taxes on the creditors by diminishing the estate.
In In re Earned Income Tax Credit Exemption Constitutional Challenge Cases,
I made the following comments about the nature and purpose of the earned income
The EIC is a refundable tax credit. As the Tenth Circuit noted in
In re Montgomery, an individual’s tax credits are applied to tax owed fora taxable year and if they exceed the amount of tax owed, they areconsidered an overpayment that is refunded. So, whether an individualhas actually paid in withholdings or not, she is entitled to receive theexcess credit as if she had. The EIC “was enacted to reduce the
disincentive to work caused by the imposition of Social Security taxes onearned income (welfare payments are not similarly taxed), to stimulatethe economy by funneling funds to persons likely to spend the moneyimmediately, and to provide relief for low-income families hurt by risingfood and energy prices.” As the Tenth Circuit Bankruptcy Appellate Panelhas noted, “the EIC benefits low-income married couples and heads ofhouseholds with qualifying dependent children.” The state’s EIC iscomputed as a percentage of the federal EIC, currently set at 18 per cent.7
7 In re Earned Income Tax Credit Exemption Constitutional
Challenge Cases, 477 B.R. 791, 796-97 (Bankr. D. Kan. 2012). See KAN. STAT. ANN. §
Case 12-11246 Doc# 39 Filed 09/24/13 Page 8 of 19
In support of his position here, the trustee cites several cases that support the
general proposition that the EIC can be apportioned. In In re Montgomery, which the
Tenth Circuit Court of Appeals decided before the legislature enacted KAN. STAT. ANN.
§ 60-2315, the Circuit held that the prepetition portion of a Kansas debtor’s EIC was
property of the bankruptcy estate and subject to the same proration required under
Barowsky as the rest of the tax refund.8 Later in In re Borgman, the Tenth Circuit
held that a Colorado statute exempting the “full amount of any . . . tax refund
attributed to an earned income tax credit or a child tax credit” does not permit the
debtor to retain the portion of his refund that is attributable to the child tax credit
(different from the EIC) because, unlike the EIC, that credit is not refundable under
I.R.C. § 6401.9 In that case, the debtors had no EIC, only the child tax credit and
overpayments.10 The Circuit affirmed the holdings of both Colorado bankruptcy judges
who had concluded that because the child tax credit was not refundable, it could not
make up any part of the refund.11 Holding otherwise would effectively force the
exemption of non-refundable overpayments that are not otherwise exempt under
Colorado law. Borgman bars the exemption of non-refundable elements of a tax refund
8 224 F.3d 1193, 1195 (10th Cir. 2000).
9 698 F.3d 1255, 1258 (10th Cir. 2012).
10 Id. at 1258-59. The Borgman opinion addressed the identical issue in two
separate bankruptcy cases (Borgman and Dunckley) – whether the nonrefundableportion of the federal child tax credit could be exempted under Colorado law.
11 Id. at 1261.
Case 12-11246 Doc# 39 Filed 09/24/13 Page 9 of 19
because there is nothing in the debtor’s hands to exempt.12 The converse of this rule
may be that a debtor can only exempt what is attributable to the exempt elements of
the refund, requiring the proration the trustee advocates in the Roys’ case to determine
what precisely is attributable to the credit.
But in In re Westby, Judge Karlin refused to permit an allocation of the EIC into
pre- and postpetition portions.13 She correctly held that the Barowsky proration did not
apply to the EIC because the EIC is exempt, noting that “Senate Bill No. 12 explicitly
exempts the “maximum credit” for “one tax year.” Therefore, a pro rata division would
not be appropriate, because Senate Bill No. 12 exempts the property from the estate
entirely.”14 That reasoning disposes of the point here, too. Because the entire EIC is
exempt, it should not be burdened with paying the debtor’s tax bill. This conclusion is
buttressed by the long-held Kansas view that exemptions are to be liberally construed
in favor of the debtor.15
Another facet of Kansas exemption law also undercuts the trustee’s argument.
The Kansas Supreme Court has historically rejected creditors’ efforts to marshal a
debtor’s assets in a way that would invade their homestead exemption, instead holding
12 Id. at 1262.
13 473 B.R. 392 (Bankr. D. Kan. 2012), aff’d 486 B.R. 509 (10th Cir. BAP 2013),
appeal dismissed, Williamson v. Westby (In re Westby), Case No. 13-3044 (10th Cir.
Mar. 29, 2013)
14 Id. at 421.
15 Hodes v. Jenkins (In re Hodes), 308 B.R. 61, 65 (10th Cir. BAP 2004);
Nohinek v. Logsdon, 6 Kan. App. 2d 342, 344, 628 P. 2d 257 (1981).
Case 12-11246 Doc# 39 Filed 09/24/13 Page 10 of 19
that nonexempt assets must first be liquidated to pay lienholders’ and general
creditors’ debts. In the 1877 case Colby v. Crocker, creditors of Crocker’s probate estate
brought an equitable marshaling action against the estate and its secured creditors,
asking to apply the deceased’s assets to the payment of his debts in a way most
advantageous to them.16 None of these creditors held liens or other security. One of the
defendants held a mortgage on two tracts of real property, one of which was Crocker’s
homestead, occupied by his widow and children. Colby sought to force the mortgage
holder to first realize on the homestead before selling the other encumbered property
in an effort to free up nonexempt assets for the general creditors. The Kansas Supreme
Court affirmed the district court’s order denying the petition. It noted that the
equitable doctrine of marshaling requires a person with a lien on two or more funds,
one of which another person claims a lien, to satisfy his debt first from the property on
which the other person has no claim, even where the funds are of differing character
(i.e. real estate and personal property). But the court also noted that –
. . . this rule has its exceptions and limitations. Judge Story says, that “itis never applied except where it can be done without injustice to thecreditor, or other party in interest having title to the double fund, andalso without injustice to the common debtor. Nor is it applied in favor ofpersons who are not common creditors of the same common debtor, exceptupon some special equity.”17
The court then addressed the widow’s “special equity,” noting that “by our
constitution and statutes the most sedulous care has been manifested to secure the
16 17 Kan. 527 (1877).
17 Id. at 530.
Case 12-11246 Doc# 39 Filed 09/24/13 Page 11 of 19
homestead of the debtor and to his wife and family, as against all debts not expressly
charged upon it.”18 The court added that “the homestead is something toward which
the eye of the creditor need never be turned. It is an element which may never enter
into his calculations in his efforts to collect his debt.”19 Thus, unless Colby’s claim was
premised on one of the debts excepted from the homestead exemption, the rights of the
widow and her family constituted a superior equity to his and the petition to marshal
could not be granted. Cited for this proposition over the ensuing 140 years, this case
remains good law today and has been cited in Kansas and elsewhere in favor of the
proposition that creditors may not force the liquidation of a debtor’s homestead to
liquidate one creditor’s lien when that creditor has a lien on the debtor’s nonexempt
property as well.20
In Meyer v. United States, the Supreme Court held that where New York had
enacted an exemption for the proceeds of life insurance, and where its courts refused
to marshal assets to diminish those rights, requiring the I.R.S. to first enforce its tax
lien on the death benefits to the prejudice of the survivor beneficiaries would
18 Id. at 531.
19 Id., quoting Monroe v. May, Weil & Co., 9 Kan. 466, 476, 1872 WL 650
20 See In re Fox, 2000 WL 33287982 at *12 (Bankr. D. Kan. Aug. 4, 2000);
LaRue v. Gilbert, 18 Kan. 220 (1877); Frick Company v. Ketels, 42 Kan. 527, 22 P.
580 (1889); Prudential Ins. Co. Of America v. Clark, 122 Kan. 109, 251 P. 199 (1926)
(Homestead rights are superior, both in law and in equity, to the rights of generalcreditors); In re Chadwick, 114 B.R. 663 (Bankr. W.D. Mo. 1990) (applying Kansaslaw, marshaling of assets is not available where exempt property is sought to bemarshaled); Krueger v. Central Lumber Co., 56 S.D. 626, 230 N.W. 243 (1930).
Case 12-11246 Doc# 39 Filed 09/24/13 Page 12 of 19
undermine that benevolent policy of the exemption.21 The same rule should apply in
this case. Forcing the proration the trustee seeks effectively calls upon the Roys to
apply their exempt asset, the EIC portion of the refund, to the payment of a debt on
par with their nonexempt assets. Under the rule in Meyer, and, by analogy, the rule
in Colby v. Crocker, the trustee should not be permitted to marshal the debtor’s exempt
assets by requiring the EIC portion of the refund to bear some part of their tax
Finally, the trustee argues that it is unfair for the debtors to retain their entire
EIC while the unsecured creditors’ share has already been diminished by the taxing
authority’s deducting the tax owed from the refund. This is no more “unfair” than the
priority scheme of the Bankruptcy Code is. Income tax claims are typically paid before
the claims of unsecured creditors under § 507(a)(8). So even if the debtors somehow
managed to file their return but avoid application of their overpayment to their taxes,
the taxing authority would have a priority claim that would be paid before any
distribution to the unsecured creditors.
But this conclusion does not end the “proration” discussion because the trustee
also seeks to prorate the attorney’s fee assignment against the EIC’s portion of the
refunds. As previously held in this Circuit, fee assignments should be deducted from
the tax refund before it is apportioned between the pre and post-petition periods.22 This
21 375 U.S. 233, 239-240, 84 S.Ct. 318, 11 L.Ed. 2d 293 (1963).
22 Redmond v. Carson (In re Carson), 374 B.R. 247 (10th Cir. BAP 2007).
Case 12-11246 Doc# 39 Filed 09/24/13 Page 13 of 19
alone effectuates some form of proration of the fee among the refund’s elements. To the
extent that this proration impairs the EIC exemption, that impairment does not offend
Colby or Meyer because the debtors’ assignment of their refund to their lawyer was
consensual. In doing that, they waived their exemption on that portion of the EIC in
the same way a consensual mortgagor waives his or her homestead exemption when
she mortgages it.
Therefore, the trustee’s motion for turnover of the tax refunds should be granted
Federal refund $5,205.00 State refund $369.00
Less fee assignment $(169.02) Less fee assignment $(11.98)
Less EIC $(1,600.00) Less EIC $(288.00)
Remainder $3,435.98 Remainder $69.02
Estate’s share (36.88525%) $1,267.37 Estate’s Share $25.46
Small Assets and Aggregation
Finally, the debtors resist the trustee’s motion to turnover the $5.45 balance in
the debtors’ bank account on the filing date. The debtors argue that this asset is simply
too small to effectively administer and should instead be abandoned. The trustee
replies that consumers’ bankruptcy estates are frequently composed of multiple small
assets that the trustee has discretion, if not a duty, to accumulate for the benefit of the
creditors even when those assets would not, standing alone, warrant administration.
The trustee’s statutory powers and duties prescribed by the Code shed some
light on this without exactly defining the boundaries of a trustee’s discretion. Sections
Case 12-11246 Doc# 39 Filed 09/24/13 Page 14 of 19
541 and 542 make clear that the trustee may recover any property that the debtor has
or was entitled to receive on the petition date.23 In fact, § 704 directs the trustee to
“collect and reduce to money the property of the estate . . .”24 The trustee uses the
turnover power of § 542 to execute this duty. But if the trustee concludes that the
property is “burdensome to the estate” or “of inconsequential value and benefit to the
estate,” it can be abandoned.25 Any party in interest may ask the court to order the
trustee to abandon such property.26 In addition to these Code provisions, several
Bankruptcy Rules also facilitate the administration of small asset cases.27 The debtors
here argue that, given the trustee’s necessary costs incurred in recovering $5.45,
expenses that cannot help but exceed that amount, $5.45 is indeed inconsequential and
too burdensome for the estate to administer.
A few courts have addressed how far a trustee should go to recover an asset in
the context of objections to the trustees’ attorneys fees incurred in litigation that
proved unsuccessful or excessive. Even though the context of those cases is different,
it is hard to argue with their foundational principle: that no trustee has a duty to
23 11 U.S.C. § 541 and § 542.
24 11 U.S.C. § 704(a)(1).
25 11 U.S.C. § 554(a).
26 11 U.S.C. § 554(b); Fed. R. Bankr. P. 6007(b).
27 See Fed. R.Bank. P. 6004(d) permitting the expedited sale of all nonexempt
assets of an estate where they have an aggregate gross value of $2,500 or less. D.
Kan. L.B.R. 6007.1 permits the trustee to file a blanket abandonment as part of a“report of no distribution” in a no asset case.
Case 12-11246 Doc# 39 Filed 09/24/13 Page 15 of 19
“collect an asset . . . if the cost of collection would exceed the value of the asset.”28 In
general, trustees should abandon property from which the estate can expect only a
small benefit because expeditious reduction of the debtor’s property for money for
distribution to creditors is the goal of a bankruptcy case.29 But a trustee’s discretion is
not unlimited. For instance, courts have forbidden trustees to abandon hazardous or
polluted property without making provisions to mitigate its environmental or other
In connection with the “small asset” problem, a former bankruptcy judge sitting
in this division has declined to hold that there is a baseline value of assets that
trustees should administer. In In re Doughman, the debtors resisted the trustee’s
motion to turnover bank balances totaling less than $1,500.31 They argued in part that
there should be a $1,500 asset floor in consumers’ estates and that trustees should
simply be required to abandon estates of lesser amount. Judge Pearson held that doing
so would amount to judicial legislation of an exemption. Instead, he stated, “the
trustees make the decision about administration of estate assets and presumably, have
28 Matter of Taxman Clothing Co., 49 F.3d 310, 315 (7th Cir. 1995) (noting
trustee’s duty to maximize the value of net assets).
29 In re Beker Industries Corporation, 64 B.R. 900, 908 (Bankr. S.D.N.Y.
1986), rev’d on other grounds, 89 B.R. 336 (S.D.N.Y. 1988).
30 See Midlantic Nat. Bank v. New Jersey Dep't of Envtl. Prot., 474 U.S. 494,
106 S. Ct. 755, 88 L. Ed. 2d 859 (1986).
31 263 B.R. 905 (Bankr. D. Kan. 1999).
Case 12-11246 Doc# 39 Filed 09/24/13 Page 16 of 19
discretion to decline to administer small estates.”32 He reminded the parties that
trustees shouldn’t be “encouraged” to administer assets when it appears from the
outset that little or no distribution will result.33
But $5.45 is a long way from $1,500. Were it the only asset, a $5 account balance
would doubtless warrant abandonment. But it doesn’t stand alone here. The trustee’s
January interim report indicates that the estate had net value of $104.51 plus the
then-undetermined value of the income tax refunds.34 As noted above, we know that
those are approximately $1,290. The total claims filed in this case are less than
$11,651, and several of them are filed as secured, meaning that the unsecured creditors
could recover more than a 10% dividend before administrative expenses. While this is
not a staggering dividend, it is not “inconsequential.” But $5.45 is.
Trustees not only have the duty to conserve an estate’s net assets, but also to
maximize their value by weighing whether the cost of recovery will outstrip the value
recovered. In Matter of Taxman Clothing, Inc., 35 the Seventh Circuit concluded that an
attorney’s fee award was unreasonable because the trustee’s attorney pursued the
matter long after it had become “reasonably obvious” that the litigation would cost
32 Id. at 909.
34 Dkt. 25. The Court observes that the $104.51 net value listed in the report
is for the non-exempt portion of earned wages. The trustee ascribes no net value tothe account balances in the Ark Valley Credit Union.
35 49 F.3d 310 (7th Cir. 1995).
Case 12-11246 Doc# 39 Filed 09/24/13 Page 17 of 19
more than it was likely to net the estate.36 Judge Posner noted that a trustee’s
fiduciary duty of care “is not merely care, diligence, and skill in the prosecution of the
estate's claims. It is also care, diligence, and skill in deciding which claims to
prosecute, and how far.”37
On the facts before me, $5.45 is “inconsequential” because I can conceive of no
method of recovering it, short of the debtors’ voluntarily ponying it up, that would not
cost more than it is worth to recover. I cannot say generally how much is too little or
enough to administer, but “I know it when I see it.”38 This small amount of money is
not enough to warrant recovery or administration in these circumstances so the
trustee’s motion to turnover $5.45 is denied.
The Trustee’s Motion for turnover is granted in part and denied in part as
follows. That part of the motion requesting turnover of the debtors’ 2012 income tax
refunds is GRANTED. The debtors shall turnover $1,267.37 from their federal refund
and $25.46 from their state refund, for a total of $1,292.83. The balance of the trustee’s
36 Id. at 315.
38 With apologies to Justice Stewart who coined this phrase in connection
with defining obscenity, see Jacobellis v. State of Ohio, 378 U.S. 184, 197 (1964)
(Stewart, J., concurring) (“But I know it when I see it, and the motion pictureinvolved in this case is not that.”).
Case 12-11246 Doc# 39 Filed 09/24/13 Page 18 of 19
motion is DENIED.39
# # #
39 Apparently, no disagreement remains between the parties with respect to
the trustee’s motion for turnover of earned wages or their amount; that portion ofthe turnover motion has not been briefed and debtors concede non-exemptprepetition wages of $104.51 are subject to turnover. See Dkt. 34, ¶ 9. The trustee’s
turnover motion is granted to this extent with respect to earned wages.
Case 12-11246 Doc# 39 Filed 09/24/13 Page 19 of 19
- Category: Judge Nugent
- Published on 07 August 2013
- Written by Judge Nugent
- Hits: 251
Davis v. Sunflower Bank NA, 12-05038 (Bankr. D. Kan. Jul. 23, 2013) Doc. # 61
SIGNED this 23rd day of July, 2013.
OPINION DESIGNATED FOR ONLINE PUBLICATION
BUT NOT PRINT PUBLICATION
IN THE UNITED STATES BANKRUPTCY COURT
FOR THE DISTRICT OF KANSAS
A-1 PLANK & SCAFFOLD MFG, INC.
) Case No. 10-10379
) Chapter 7
CARL B. DAVIS, TRUSTEE )
Adversary No. 12-5038
SUNFLOWER BANK, N.A. )
ORDER DENYING PLAINTIFF’S MOTION FOR LEAVE
TO AMEND COMPLAINT
Case 12-05038 Doc# 61 Filed 07/23/13 Page 1 of 16
Motions for leave to amend a complaint should be freely granted in the interest
of justice. But amendments proposed more than 21 days from the filing of an answer
are not always granted, particularly when they have been proposed well after the time
scheduled for amendments, discovery has closed, and pretrial order deadlines set in the
scheduling order have passed. Denial of a motion for leave to amend is appropriate
when the moving party: (1) cannot explain the delay; (2) knew or should have known
the facts underlying the amendment when the original complaint was filed; (3) makes
the complaint a moving target; (4) attempts to salvage a lost cause; or (5) knowingly
delayed raising the issue until the eve of trial.
In this case, the movant, a successor bankruptcy trustee, relies on the nondisclosure
of a document to his predecessor as the basis for adding the novel legal claim
that transfers to the defendant Sunflower Bank, already targeted as § 548(a)
fraudulent transfers, were also preferences paid to the Bank within one year of the
petition date.1 The trustee necessarily asserts, for the first time, that the Bank was “in
control” of the debtor and is, accordingly, a statutory insider.2 The insider “control”
claim is based on a supposedly elusive document. The trustee also seeks to have this
amendment relate back to the date of the original complaint, particularly important
here as more than three years have passed since the underlying bankruptcy case was
Instead of the usual 90-day look back period for preferences, § 547(b)(4)(B)
expands the look back period to 1 year preceding the date of filing where thecreditor was an insider at the time of the transfer.
See § 101(31)(B)(iii).
Case 12-05038 Doc# 61 Filed 07/23/13 Page 2 of 16
filed and the § 546 statute of limitations has otherwise expired.3 After careful review
of the supposedly undisclosed document, I conclude that its contents were incorporated
verbatim into the additional terms of a promissory note signed by the debtor’s officers,
a copy of which was filed with the Bank’s first proof of claim on June 22, 2010,4 and
which was known well enough to the first trustee to fuel his request for clarification
concerning the document’s meaning from the Bank’s then counsel. Indeed, the first
trustee filed a complaint that referred to the control accounts referenced in the
document and sought to recover these same transfers as fraudulent, but did not plead
a § 547 insider preference claim. As explained below, the trustee’s motion to amend
should be denied because the estate’s delay in pleading this new claim is unexplained
and the estate knew of this agreement long before the pleading and discovery deadlines
passed (knowledge with which this trustee is charged), making the complaint a
The A-1 bankruptcy case began February 21, 2010 in chapter 11 and a
liquidating chapter 11 plan was confirmed on June 8, 2011. J. Michael Morris was
See Fed. R. Civ. P. 15(c) made applicable to adversary proceedings by Fed.
R. Bankr. P. 7015.
See Proof of Claim No. 60-1.
See Viernow v. Euripides Dev. Corp., 157 F.3d 785, 800 (10th Cir. 1998)
(leave to amend sought 19 months after filing the original complaint and after trialcourt had orally ruled on summary judgment motion termed “a moving target” bythe trial court). The trustee Davis appears by his attorney Kenneth Jack.
Sunflower Bank appears by its attorney Michael P. Alley.
Case 12-05038 Doc# 61 Filed 07/23/13 Page 3 of 16
appointed liquidating trustee. He commenced administration and, on February 21,
2012, two years to the day after the case was filed, he filed this six count adversary
proceeding. In Count IV of his complaint, he alleged that on October 30, 2009, the
debtor signed note 1296 with the Bank and that the note contained an agreement by
which the debtor agreed to borrow the cash value of certain life insurance policies and
deposit them to a “[Bank] controlled account for the payment of operating expenses.”6
He further pled that some of these proceeds were applied to the debts of the debtor or
of another company affiliated with the debtor (A-1 Shoring) and sought to recover those
payments as actual fraudulent transfers under § 548(a)(1)(A). Mr. Morris sought to
avoid other transfers as preferences in other counts of the complaint, but nowhere did
he allege that Sunflower Bank “controlled” the debtor or that the Bank is an insider.
On April 30, 2012, the case was converted to chapter 7 and Mr. Morris appointed
chapter 7 trustee.7 On May 16, I entered an order in the adversary proceeding adopting
the parties report of planning meeting,8 setting three critical deadlines that figure
prominently in this Order: a Fed. R. Civ. P. Rule 26(a)(1) initial disclosures deadline
of May 25, 2012, a deadline to amend pleadings of July 13, 2012, and a discovery
deadline of September 28, 2012. Of these three deadlines, only the discovery period has
been extended and it terminated on November 29, 2012.9 Thus, for Fed. R. Civ. P. 16
See Adv. Dkt. 1, p. 4, ¶ 16.
7 Dkt. 481.
8 Adv. Dkt. 11, 12.
9 Adv. Dkt. 15.
Case 12-05038 Doc# 61 Filed 07/23/13 Page 4 of 16
scheduling purposes, discovery has been closed in this case for seven months and the
pleadings have been closed for a year. On December 21, 2012, the parties jointly moved
to extend the pretrial order deadline to February 1 and the dispositive motions
deadline to February 15, 2013; the Court granted the requested extensions.10
On January 10, 2013, Mr. Morris resigned as trustee and Mr. Davis was
appointed to succeed him. The resignation may have been prompted by the Bank’s
discovery that Morris’s firm had advised it concerning a transaction unrelated to this
case, though the record is sparse concerning the details or the timing of that discovery.
On January 28, 2013, Mr. Davis’s firm was employed to represent the estate in this
and other matters. On January 30, the same day Davis was substituted as party
plaintiff, he filed a motion to extend the final pretrial order deadline to April 4 and the
dispositive motion deadline to April 18.11 He neither sought to reopen discovery or to
extend the time in which to amend the complaint, both of which had long since expired.
An order extending the dispositive motion and pretrial order deadlines was entered
without objection.12 Davis filed this motion to amend the complaint on April 3.13
Sunflower Bank filed its motion for summary judgment on April 18.14 Both parties
Adv. Dkt. 20, 21.
11 Adv. Dkt. 24.
Adv. Dkt. 26.
13 Adv. Dkt. 29.
Adv. Dkt. 33. During the pendency of this amendment motion, the partiescompleted briefing on the summary judgment motion and it was recently placedunder advisement.
Case 12-05038 Doc# 61 Filed 07/23/13 Page 5 of 16
have briefed the amendment motion and the matter is ripe for decision.
The Proposed Amendment
Davis seeks to amend Count III of the complaint to add allegations that
Sunflower Bank was an insider of the debtor by virtue of a “control agreement” and
“relationship of control” between the Bank and the debtor. Because of that
relationship, Davis seeks to invoke the 1-year look back period from the petition date
and recover as a preference, the transfer of $647,397 of life insurance proceeds
borrowed by A-1, deposited in the control account, and applied to A-1's and A-1
Shoring’s debts.15 These appear to be the same transfers that Mr. Morris sought to
avoid in Count IV as fraudulent under § 548(a)(1)(A). Davis justifies the late
amendment with a series of arguments directed at the Bank’s conduct in allegedly not
disclosing the “control agreement” until it filed its summary judgment motion on April
18 and securing Morris’s resignation shortly before the previous set of deadlines were
about to expire. Davis argues that because the Bank had possession of the control
agreement and kept it from Morris, the balance of harm weighs heavily in favor of the
trustee and that the Bank will not be prejudiced by any delay that allowing the
amendment might cause. Moreover, Davis argues that without possession of the
agreement, Morris could not have known of the insider relationship and, naturally,
could not have pleaded it in the first complaint. The Bank says that Morris and it
participated in lengthy and cooperative informal discovery throughout his
See § 547(b)(4)(B).
Case 12-05038 Doc# 61 Filed 07/23/13 Page 6 of 16
administration. Indeed, the Bank says it gave Morris over 3,400 pages of documents.
Davis says that when he received Morris’s file, it contained over 7,600 pages of
documents. Curiously, neither party takes a definitive position on whether the control
agreement was contained in these behemoth files.16 But before we dispose of that issue,
we should first address what the “control agreement” is and whether Morris had notice
of its content in time to allege anything about it in the original February 21, 2012
complaint or to amend it by the July 13, 2012 amendment deadline.
The “Seven Party Agreement” and Promissory Note 1296
Resting in the bankruptcy clerk’s safe are the sealed exhibits to the Bank’s
summary judgment motion, all 896 pages of them. Among them is Exhibit 39, a
document titled “A-1 Plank & Scaffold Mfg. Inc/A-1 Scaffold & Shoring,
LLC/Allenbaugh Family, L.P. Memo Agreement October 9, 2009.”17 We will refer to this
agreement as the trustee does, the “Seven Party Agreement” or “7PA.” In the 7PA, the
Bank agrees to “cover the payroll expenses for” the A-1 entities and the family
It is not apparent that the documents produced by the Bank to Mr. Morrisduring informal discovery were bate-stamped or indexed in some fashion to identifythose documents produced by the Bank in discovery. Nor is it apparent that Mr.
Morris indexed the documents he received in discovery from the Bank to identifythe documents produced by the Bank. The Court observes that the summaryjudgment exhibits are paginated with a letter/6 digit number stamp. For example,
Exhibit 39 (the so-called “control agreement”) is marked SFBMSJ000418-422,
presumably identifying it as a Sunflower Bank Motion for Summary Judgmentdocument. The parties’ identification or indexing of documents produced andreceived in discovery is a common and prudent litigation practice that eliminatesany confusion or dispute whether a particular document was produced, particularlyin a document-intensive case.
Dkt. 36, Ex. 39, pp. 419-422 (sealed).
Case 12-05038 Doc# 61 Filed 07/23/13 Page 7 of 16
partnership for October 9, 2009 in exchange for, among other things, the two A-1
entities and the Allenbaugh family (their owners) agreeing to borrow the cash value
of life insurance policies owned by A-1 Plank, pay a second mortgage of Dwight and
Jenny Allenbaugh, and deposit the balance in the “Sunflower Bank controlled
operating account.”18 The policies were also to be assigned to the Bank as collateral.
Under another part of the agreement, other cash generated by the entities was to be
deposited in the controlled accounts with 70% being applied to the entities’ respective
bank debt and the remainder retained by the entities for the payment of current
expenses as specifically approved by the Bank. The 7PA contains a number of other
very typical workout agreement terms and conditions, all of which are quite favorable
to the Bank. The 7PA specified that it was “in force for no more than 90 days.”
The claims register in this case contains Claim 60-1 of Sunflower Bank, filed in
June of 2010. Attached to that document is a copy of promissory note 1296, the “Note,”
which incorporates the 7PA by reference and verbatim at paragraph 11 nearly the
entire text of the 7PA,19 except that the provisions for the collateral assignment of the
insurance policies and several other matters not germane to this motion have been
stricken through and initialed by the makers, A-1's officers and guarantors. So the
substance of the 7PA has been of record in this case since June 2010 – before Morris’s
appointment as liquidating trustee.
Id. at ¶ 2.
19 Paragraph 11, Additional Terms, recites ¶ 2-10 of the 7PA and thereporting requirements, but omits ¶ 1, not relevant here. Cf. Ex. 39 and Note, ¶ 1.
Case 12-05038 Doc# 61 Filed 07/23/13 Page 8 of 16
Davis implies that neither he nor Morris ever got the 7PA in disclosure or
discovery. He notes that Sunflower never filed a certificate of compliance with the
initial disclosure deadline as our local rules require. Indeed, neither party filed any
certificates concerning discovery matters. And, neither ever complained to the Court
about the other’s failure to comply with discovery requirements of any kind. Sunflower
suggests in its brief that all pre-complaint investigation as well as post-complaint
discovery was done informally and cooperatively among counsel. Davis’s brief contains
a copy of a correspondence thread between Morris and Linda S. Parks, Esq., another
of the Bank’s counsel, in which Morris asks specific questions about the existence of
a control agreement or arrangement that can only have been prompted by his review
of the Note, if not the 7PA itself. This correspondence took place in July of 2011, well
before the complaint was filed.20 In a letter dated July 12, Morris asks about the
insurance policies, the borrowing against them, and how those proceeds were spent.
He notes –
Beginning in October, 2009, it appears SFB [Bank] “controlled” the A1Paccounts at SFB. . . Did anyone at the Debtor have any control ordiscretion over these transfers? *** Also there are several disbursements
for “expenses approved” and “debit force post.” Explain the process forobtaining “approval” of an “expense.” Were any “expenses” presented anddenied “approval?”21
Attorney Parks responded that “SFB had the type of control contemplated by KSA 849-
312(b) . . . in that there [sic] it had a security interest in a deposit account perfected
Adv. Dkt. 53, Ex. C and D.
21 Adv. Dkt. 53, Ex. C.
Case 12-05038 Doc# 61 Filed 07/23/13 Page 9 of 16
by control . . . [b]ut we cannot say that the debtor had no control or discretion.”22 She
went on to note that “[a]s a part of these negotiations, the parties entered into a memo
agreement with A1 Plank and their respective guarantors.”23 Even if Morris didn’t
know about the 7PA before he wrote his letter of July 12, Parks’s response placed him
on notice of its existence shortly thereafter. And, as noted above, even if Morris didn’t
have possession of the 7PA then, he certainly knew of its provisions, likely from his
review of the Bank’s proof of claim and the contents of the Note.24
Morris’s original complaint also demonstrates that he knew of the existence of
the contents of the 7PA as they were quoted in the Note. He referred to the payment
of the insurance loan proceeds into the “bank controlled” account and asserted that the
application of those funds to A-1 debts was an avoidable fraudulent transfer. He had
no less information at hand about the matter of control than does Davis today. That
allows me to conclude that Morris, for whatever reason, opted not to assert that the
Bank was an insider of the debtor or that these payments were avoidable preferences.
Applying Rule 15's Standards for Allowing or Denying an Amendment
Fed. R. Civ. P. 15(a)(2) provides that, after a responsive pleading has been filed,
“a party may amend its pleading only with the opposing party’s written consent or the
Adv. Dkt. 53, Ex. D.
Id. Emphasis added.
24 As noted previously, paragraph 11 Additional Terms of Note 1296 attachedto the Bank’s proof of claim incorporates by reference “THE TERMS,
CONDITIONS, AND REQUIREMENTS OF THE MEMO AGREEMENT DATED
OCTOBER 9, 2009.”
Case 12-05038 Doc# 61 Filed 07/23/13 Page 10 of 16
court’s leave.”25 Leave to amend is to be “freely given when justice so requires.”26
Granting leave to amend rests in the sound discretion of the court.27 Although Rule 15
should be interpreted with extreme liberality, leave to amend is not to be granted
automatically. In Foman v. Davis, 28 the Supreme Court held:
If the underlying facts or circumstances relied upon by a plaintiff may bea proper subject of relief, he ought to be afforded an opportunity to testhis claim on the merits. In the absence of any apparent or declaredreason-such as undue delay, bad faith or dilatory motive on the part ofthe movant, repeated failure to cure deficiencies by amendmentspreviously allowed, undue prejudice to the opposing party by virtue ofallowance of the amendment, futility of amendment, etc.-the leave soughtshould, as the rules require, be ‘freely given.’29
The Tenth Circuit Court of Appeals has held that denial of leave to amend is
appropriate when the amending party: (1) has no adequate explanation for the delay;30
(2) knows or should have known of the facts upon which the proposed amendment is
Fed. R. Bankr. P. 7015 applies Rule 15 to adversary proceedings.
Fed. R. Civ. P. 15(a)(2).
27 Zenith Radio Corp. v. Hazeltine Research, Inc., 401 U.S. 321, 330 (1971).
371 U.S. 178 (1962).
Id. at 182, quoting Fed. R. Civ. P. 15(a).
Minter v. Prime Equip. Co, 451 F.3d 1196, 1206 (10th Cir. 2006); Frank v.
U.S. West, 3 F.3d 1357, 1365-66 (10th Cir. 1993); see also Durham v. Xerox Corp., 18
F.3d 836, 840 (10th Cir. 1994) (“[U]nexplained delay alone justifies the districtcourt's discretionary decision.”); Fed. Ins. Co. v. Gates Learjet Corp., 823 F.2d 383,
387 (10th Cir. 1987) (“Courts have denied leave to amend in situations where themoving party cannot demonstrate excusable neglect. For example, courts havedenied leave to amend where the moving party was aware of the facts on which theamendment was based for some time prior to the filing of the motion to amend.”)
Case 12-05038 Doc# 61 Filed 07/23/13 Page 11 of 16
based but failed to include them in the original complaint;31 (3) makes the complaint
“a moving target;”32 (4) attempts to “salvage a lost case by untimely suggestion of new
theories of recovery;”33 or (5) “knowingly delay raising [an] issue until the eve of
trial.”34 Several of these factors militate toward denial of the proposed amendment
while others are not implicated on the record before the Court.
As to the lack of an adequate explanation for the delay, Davis relies on the
alleged unavailability of the 7PA to Morris and himself to explain the need to amend
the petition. But as noted above, the content of the 7PA has been in the record of this
case since at least the time of the filing of the Bank’s claim. That Morris knew the facts
upon which the proposed amendment is based is shown by his specifically seeking to
recover the same transfer as a fraudulent one in count IV, based upon the same facts.
Presumably he made a prudential judgment, after his assessment of the Bank
controlled account and inquiry of Ms. Parks, not to seek avoidance of these transfers
State Distribs., Inc. v. Glenmore Distilleries Co., 738 F.2d 405, 416 (10thCir. 1984).
Viernow v. Euripides Dev. Corp., 157 F.3d 785, 800 (10th Cir. 1998) (Whereleave to amend sought 19 months after filing the original complaint and after trialcourt had orally ruled on summary judgment, trial court termed the case “a movingtarget.”).
Id.; Pallottino v. City of Rio Rancho, 31 F.3d 1023, 1027 (10th Cir. 1994)
(Trial court not required to consider theories seriatim; denial of leave to file secondamended complaint to add new theory was not an abuse of discretion whereprevious legal theory was dismissed, leave filed 8 months after original complaintand not based on newly discovered evidence previously unavailable).
Walters v. Monarch Life Ins. Co., 57 F.3d 899, 903 (10th Cir. 1995).
Case 12-05038 Doc# 61 Filed 07/23/13 Page 12 of 16
as one-year preferences and nowhere in the original complaint is there an allegation
that the Bank is an insider of the debtor. Certainly adding this new allegation at a
stage in the case after the amendment period and discovery are closed, and a summary
judgment motion is pending, serves to make the complaint a “moving target.” The
trustee would still need to prove under this new insider-preference theory that merely
requiring a “control account” renders a secured creditor an insider.
A-1 was a corporation. Section 101(31)(B) defines an insider of a corporation as
a director, an officer, or a “person in control” of it. A “person” is defined as, among other
things, a corporation. The trustee would have to show that the Bank actually controlled
the debtor to prove that per se insider status. A “non-statutory” insider is one whose
relationship to the debtor is not specifically enumerated in § 101(31), but who is closely
related to the debtor and who deals with the debtor at less than arm’s length.35 To
demonstrate that, the trustee would need to show “on the evidence [that the Bank]
remained in control of the company.”36 Only if insider status could be established would
the trustee be able to avoid and recover the alleged transfers that occurred more than
90 days before the A-1 case was filed.
Given that the summary judgment motion is pending and its merit not yet
evaluated, I am unwilling to speculate whether the original claim directed at the
In re U.S. Medical, Inc., 531 F.3d 1272, 1278 (10th Cir. 2008) (Closerelationship alone is insufficient to find a non-statutory insider, not dealing at arm’slength is also required.).
Rupp v. United Security Bank (In re Kunz), 489 F.3d 1072, 1079 (10th Cir.
Case 12-05038 Doc# 61 Filed 07/23/13 Page 13 of 16
insurance proceeds transfers (count IV) is somehow faulty, or whether Davis seeks to
add this new insider-preference claim to “salvage a lost case.” Nor is there any
suggestion that Davis has “knowingly delayed” raising the insider issue. But at this
stage of the proceedings, where a summary judgment motion has been fully briefed,
where formal discovery has been closed, and where informal discovery (albeit by
Davis’s predecessor) has been voluminous, adding an insider-preference claim that is
predicated on establishing that the Bank “controlled” the debtor would require me, in
fairness, to reopen discovery and table the summary judgment motion as well as the
final pretrial order, resulting in considerable delay to all parties.37 In so concluding, I
distinguish between affording the successor trustee some latitude in responsive
briefing and trial preparation given his relative newness to the adversary proceeding
and allowing him to restart the entire pretrial process by adding a new and potentially
contentious claim – one that his predecessor declined to plead. In short, Foman makes
clear that leave to amend is to be “freely” given, but not automatically allowed. It
should not be allowed here.
Successor Trustee Bound by Predecessor Trustee’s Acts
Section 323(a) makes trustees the representatives of the bankruptcy estate who
may sue and be sued on behalf of the estate. Avoidance claims are claims that trustees
assert (or not) on behalf of the estate. That the estate is continuous notwithstanding
the removal or resignation of a trustee is made clear by § 325 which states that a
37 Indeed, the trustee acknowledges in his motion the necessity forsupplemental discovery if his amendment is allowed. See Dkt. 29, ¶ 11.
Case 12-05038 Doc# 61 Filed 07/23/13 Page 14 of 16
vacancy in the office of the trustee “does not abate any pending action or proceeding”
and the successor trustee is substituted automatically for the predecessor in any
pending matter.38 It is also clear that waivers made by a debtor in possession in
chapter 11 bar the chapter 7 trustee of the same estate from pursuing actions waived
even after conversion.39 While no express waiver occurred in this case, Trustee Morris
did not plead the insider-preference claim that Trustee Davis seeks to plead. That
claim is now barred by § 546(a). Even though Morris clearly knew about the “controlled
accounts,” he opted not to allege on behalf of the estate that the Bank was an insider
or assert a preference claim based on the insurance proceeds transfers. As a successor
representative of the same estate, Davis is bound by that decision and its
The Effect of “Disqualification”
Davis also argues that the timing of Morris’s resignation, which was apparently
prompted by the Bank’s discovery of Morris’s law firm’s prior representation of it on
an unrelated matter, operated to deprive him, as successor trustee, of an opportunity
to pursue this new legal theory. As support for that, the trustee includes transcribed
e-mail traffic between two members of the U.S. Trustee’s office setting the above
information out. Davis’s suggestion that the Bank’s refusal to consent to Morris’s
38 Fed. R. Bankr. P. 2012(b).
39 The Tenth Circuit has held that when a chapter 11 debtor in possessionwaives the right to bring an avoidance action against a secured lender, the chapter7 trustee is bound by the same waiver. See In re MS55, Inc., 477 F.3d 1131, 1135
(10th Cir. 2007).
Case 12-05038 Doc# 61 Filed 07/23/13 Page 15 of 16
continuing as counsel to the estate in this action ignores Morris’s firm’s potential
ethical obligations to the Bank that could have arisen out of the prior representation
(about which we know very little). It is certainly possible that the Bank’s permission
would have been necessary to Morris continuing and, while the timing is intriguing,
that fact remains that when a lawyer is informed of a potential conflict of interest, even
one that can be waived, he must either secure a waiver or withdraw.40
Trustee Davis’s motion for leave to amend the complaint, dkt. 29, to assert an
insider-preference claim relating to transfers of life insurance proceeds is hereby
The Court will conduct a status conference in this matter on September 19,
2013 at 9:50 a.m. Counsel shall submit an agreed final Pretrial Order to the Court
by September 16, 2013 for its review.
# # #
See KAN. SUP. CT. RULE 226, KRPC 1.9.
Case 12-05038 Doc# 61 Filed 07/23/13 Page 16 of 16
- Category: Judge Nugent
- Published on 08 October 2013
- Written by Judge Nugent
- Hits: 106
In Re Little, 12-12650 (Bankr. D. Kan. Sep. 25, 2013) Doc. # 54
SIGNED this 24th day of September, 2013.
NOT DESIGNATED FOR ONLINE OR PRINT PUBLICATION
IN THE UNITED STATES BANKRUPTCY COURT
FOR THE DISTRICT OF KANSAS
Case No. 12-12650
ORDER SUSTAINING 21ST MORTGAGE CORPORATION’S
OBJECTION TO CONFIRMATION AND DENYING
CONFIRMATION OF DEBTOR’S CHAPTER 13 PLAN
Section 506(a)(2) of the bankruptcy code provides that when a secured claim is
allowed in a chapter 7 or 13 case, the value of the security is the property’s
replacement value on the date of the petition “without deduction for costs of sale or
marketing.” If the debtor acquired the property for personal or household use, the
replacement value is determined at the time value is determined and the property’s
Case 12-12650 Doc# 54 Filed 09/24/13 Page 1 of 6
age and condition can be considered.1 This case involves a manufactured home that is
debtor’s place of residence, and her claim that the home is worth far less than what
21st Mortgage Corporation, her purchase money lender, claims. If she’s correct, her
chapter 13 plan is feasible and can be confirmed. If the home is worth substantially
more as the lender claims, it cannot.
Ms. Little’s home is a 1996 Fleetwood model. She purchased it used in 2007 and
testified that it looked good then, but that it had been damaged in transit to the
community where it is presently set. The debtor assigned what appears to be a
somewhat arbitrary value of $8,000 to the home, but offered no actual appraisal
evidence. Ms. Little notes, and her photographs support, that the home has sustained
interior water damage that she attributes to problems with the roof. She also says that
there are plumbing issues and that the home needs to be leveled. She testified that
replacing the roof would cost between $3,000 and $4,000 while leveling the home would
cost $2,000 to $3,000. She noted on cross examination that she had done some repairs
to the roof that were paid for by insurance. She subsequently had the ceilings repaired
as well, but new stains appeared. She believes there has been further roof damage, and
until the repair work is completed, the home is worth only $8,000.
21st Mortgage presented an appraiser, Dan Pate, who testified that the home,
1 11 U.S.C. § 506(a)(2).
Case 12-12650 Doc# 54 Filed 09/24/13 Page 2 of 6
net of necessary repairs, was worth $23,400.2 He arrived at this amount by applying
the N.A.S. manual guidebook3 to the base model of the mobile home ($18,900),
considering the size, age, make and model of the home and giving a location and
condition adjustment. Mr. Pate then added about $6,200 to the base value to recognize
the value of “options” the home came with. These options include “house-type” roofing,
storm windows, full baths, certain appliances and fixtures, heating and air
conditioning units, window treatments, and skirting. The value of all of these “options”
is reduced for the age of the home. He deducted needed repair costs of $315 from the
home value as follows: $200 which represents his estimate of the cost of roof repairs
(replacing the roof cap); $45 for other necessary exterior repairs; and $70, the cost of
removing the water stains from the ceiling using the product “Kilz.” Mr. Pate also
made a deduction to the base value for missing running gear components.
Mr. Pate’s testimony was reliable and credible, though the photographs both he
and Mrs. Little offered suggest that the interior water stain damage might cost more
than $70 to repair. While he agreed that a new roof might cost between $3,000 and
$3,500, he stated that replacing the ridge cap at significantly lower expense might be
all that was necessary. He stated that he used the NADA cost guide to value the
2 Ex. A.
3 Pate stated that the National Appraisal System (N.A.S.) is a product ofNADA and a recognized value guide in the industry.
Case 12-12650 Doc# 54 Filed 09/24/13 Page 3 of 6
Section 506(a)(2) governs both the timing and the method of evaluating personal
property owned by an individual debtor.5 The statute provides that a chapter 7 or 13
individual debtor’s property is to be valued at “replacement value” as of the date of the
petition without deduction for sale or marketing costs. But, the replacement value of
property that is acquired for personal, family or household purposes is what a retail
merchant would charge considering the age and condition of the property at the time
it is valued.6 Ms. Little undoubtedly acquired her home for personal use, so we must
value her property as of the hearing date, June 18, 2013, and consider its age and
condition in the process.
In In re Kollmorgen, I noted that other courts determine a mobile home’s value
using the NADA retail guide.7 That guide is “ based on the general specifications of the
subject home and ‘is considered a Depreciated Replacement Cost in Retail Dollars. By
4 This is a core proceeding under 28 U.S.C. § 157(b)(2)(L) over which theCourt has jurisdiction pursuant to 28 U.S.C. §§ 157(a), (b)(1) and 1334(b). David
Lund appeared as attorney for the debtor Ms. Little. Tyson C. Langhofer appearedas attorney for 21st Mortgage. Karin N. Amyx appeared as attorney for the chapter13 trustee, Laurie B. Williams.
5 Under Kansas law, a manufactured home is deemed to be personal propertyunless its certificate of title has been eliminated in accordance with the statutory
process. See KAN. STAT. ANN. §§ 58-4204(a) (2012 Supp.) and 58-4214(2005).
6 See In re Cook, 415 B.R. 529, 533-34 (Bankr. D. Kan. 2009) (section 506(a)(2)
valuation of motor vehicle is as of the date of valuation hearing).
7 In re Kollmorgen, Case No. 11-10904, 2012 WL 195200 at *3 (Bankr. D.
Kan. Jan. 20, 2012) (cases cited in footnote 19).
Case 12-12650 Doc# 54 Filed 09/24/13 Page 4 of 6
definition the Depreciated Replacement Cost is the cost to replace and [sic] item less
accrued depreciation.... Unlike cars, the NADA value as to mobile homes tells what the
[mobile home] will actually sell for.’ ”8 In Kollmorgen, I also noted that the value guide
is the starting point for mobile homes and that the adjustments are based on
replacement costs to “adjust the retail value to address the specific components and
condition of the subject manufactured home as § 506(a)(2) requires for personal use
As in Kollmorgen, the debtor did not challenge the amounts of the adjustment
costs; instead she claims the mobile home requires more repair. But she offered
nothing in evidence to support a different finding as to the cost of the interior stain
repairs and we are left with only her testimony that replacing the roof rather than the
ridge cap is necessary. Courts place weight on value evidence that is supported by
testimony of the actual appraiser.10 The debtor provided no such evidence. Because the
evidence to support her proposed value of $8,000 is outweighed by the credible expert
evidence offered by 21st Mortgage, I conclude that it is more likely than not that the
value of the home is $23,400 as the lender asserts. 21st Mortgage’s objection to
confirmation is sustained.11
8 Id. at *3, citing and quoting In re Coleman, 373 B.R. 907, 913 (Bankr. W.D.
9 Id. at *4.
10 In re Tucker, 2013 WL 3230615 at *6 (Bankr. M.D. Ga. June 25, 2013).
11 Dkt. 24 and 12.
Case 12-12650 Doc# 54 Filed 09/24/13 Page 5 of 6
In light of that conclusion, the debtor’s plan is not feasible at its current
proposed payment level of $275 per month. The Trustee’s counsel stated at the hearing
that the payment would need to be increased to $597 per month if the home were
valued at $23,400. Confirmation is therefore denied, but the debtor is granted 28 days
to offer an amended plan.
# # #
Case 12-12650 Doc# 54 Filed 09/24/13 Page 6 of 6
- Category: Judge Nugent
- Published on 24 July 2013
- Written by Judge Nugent
- Hits: 254
In Re Keith, 10-12997 (Bankr. D. Kan. Jul. 9, 2013) Doc. # 95
SIGNED this 8th day of July, 2013.
DESIGNATED FOR ON-LINE PUBLICATION
IN THE UNITED STATES BANKRUPTCY COURT
FOR THE DISTRICT OF KANSAS
JANFORD R. KEITH,
Case No. 10-12997
Since 1986, family farmers have been able to reorganize their farming
operations in chapter 12.1 Even though that chapter gave them the ability to cram
down secured claims for payment over time, family farmers who disposed of their farm
1 Chapter 12 has not been in continuous effect since 1986, having lapsed in1998 only to be retroactively renewed twice until being made permanent in 2005with the enactment of the Bankruptcy Abuse Prevention and Consumer ProtectionAct of 2005. Pub.L. No. 109-8, § 1001(a)(1), April 20, 2005, 119 Stat. 23.
Case 10-12997 Doc# 95 Filed 07/08/13 Page 1 of 27
assets in liquidation sales or whose assets were foreclosed and sold found themselves
saddled with significant non-dischargeable tax liability arising from the gains realized
on those sales. Prior to 2005, those tax obligations were priority claims under
§507(a)(8) that had to be paid in full under the farmer’s chapter 12 plan.2 When
Congress made chapter 12’s enactment permanent as part of the Bankruptcy Abuse
Prevention and Consumer Protection Act of 2005, it amended §1222(a)(2) by adding
subpart (A) which strips certain gain-based tax claims of their priority and allows them
to be paid pro rata among the other unsecured claims and discharged when the farmer
debtor’s plan is complete.
After §1222(a)(2)(A) took effect, the Internal Revenue Service tried to limit its
effect on revenue collection by claiming three things. First, the IRS urged bankruptcy
courts all over farm country to conclude that only claims that arose from prepetition
sales of farm assets were eligible for this favorable treatment. The IRS won that battle
in the United States Supreme Court in Hall v. United States. 3 Second, the IRS
contended that only the tax generated by gain on the sale of capital assets, as opposed
to ordinary farm product sales, qualifies for unsecured treatment. Third, the IRS
contended that the unsecured portion of the debtor’s prepetition taxes should be
determined by prorating the debtor’s total tax liability by the portion of it that is
generated by taxable gain. Hall addressed neither of these latter two issues.
2 See former § 1222(a)(2) (2004).
3 ___ U.S. ___, 132 S. Ct. 1882, 182 L.Ed. 2d 840 (2012).
Case 10-12997 Doc# 95 Filed 07/08/13 Page 2 of 27
The Keiths filed this case before Hall was decided. After it was decided, they and
the IRS reserved in the confirmation order the issues of what part of their income tax
debt could be treated as an unsecured claim under § 1222(a)(2)(A) and what method
of calculating that tax liability should be used.4 The Keiths and IRS stipulated to the
facts and submitted memoranda of law.5
I must first decide whether the income tax liability generated by the debtors’
farm income from the prepetition sale of livestock and crops they raised and reported
on Schedule F – Profit or Loss from Farming (Form 1040) of debtors’ 2009 income tax
return qualifies as a general unsecured claim under § 1222(a)(2)(A). If it does, I then
consider whether the marginal allocation or the proportional allocation method should
be used to calculate how much of the IRS’s claim is entitled to priority. The
Government contends that Schedule F farm income is not entitled to § 1222(a)(2)(A)’s
favorable treatment. It includes all of the debtors’ 2009 income on Schedule F in the
priority tax calculation and asserts that its priority claim amounts to $99,252 using the
proportional allocation method. The debtors claim the income from the sale of livestock
and crops on their Schedule F should receive favorable treatment under §
1222(a)(2)(A). They say that the Government should have employed the marginal
allocation method for calculating its priority tax claim. They calculate the
4 Dkt. 60, pp. 1-3.
5 Dkt. 81, 86-88. Debtors appear by their attorney W. Thomas Gilman ofRedmond & Nazar, L.L.P. The IRS appears by its attorneys Kathryn Keneally,
Assistant Attorney General, U.S. Dept. of Justice, Tax Div. and Martin M.
Shoemaker, U.S. Dept. of Justice, Tax Div.
Case 10-12997 Doc# 95 Filed 07/08/13 Page 3 of 27
Government’s priority tax claim to be $26,433 and, if the crop insurance proceeds they
reported on Schedule F income also qualify for § 1222(a)(2)(A) treatment, it would
shrink to $2,380.
After careful carefully considering both questions, I conclude that the proceeds
of sales of farming end products – feeder cattle and crops raised by the debtors – and
crop insurance proceeds are not farm assets “used” in a farming operation and
therefore are not entitled to the favored treatment of § 1222(a)(2)(A). I also conclude
that properly applying § 1222(a)(2)(A) requires the Government to employ the marginal
allocation method in calculating the extent of its priority tax claim.
The court has jurisdiction of both the allowance of claims against the estate and
plan confirmation under 28 U.S.C. § 157(b)(2)(B) and (L).6 On August 16, 2011, I
confirmed the debtors’ chapter 12 plan subject to determining the proper treatment of
the IRS’s tax claim under § 1222(a)(2)(A) and determining the amount of its priority
Burden of Proof
This matter requires the Court to determine what portion of the IRS’s allowed
tax claim will receive priority payment (payment in full under § 1222(a)(2)) and
whether the debtors’ proposed plan treatment complies with the provisions of chapter
6 28 U.S.C. § 157(b)(1) and § 1334.
7 Dkt. 60.
Case 10-12997 Doc# 95 Filed 07/08/13 Page 4 of 27
12. The IRS timely filed its proof of claim.8 The Government’s proof of claim is prima
facie evidence of the validity and amount of the claim.9 When the debtors object to the
proof of claim, they bear the burden of producing evidence and facts to meet the
presumed validity of the filed claim.10 If debtors are successful in meeting that
presumption, the burden shifts to the IRS to prove the validity and amount of its
claim.11 At the same time, the debtors, as the plan proponent, bear the burden of
proving that their plan complies with the provisions of § 1222, including the plan
treatment to be afforded priority claims in subsection (a)(2)(A).12
The debtors’ 2009 federal income tax return is dated July 8, 2010.14 They
reported a tax due of $297,081, after a $838 credit for tax payments. They filed this
case on August 30, 2010 and their chapter 12 plan on November 29, 2010. Under the
plan, debtors proposed to treat all of their tax debt as a § 1222(a)(2)(A) general
8 Dkt. 81, ¶ 5.
9 Section 502(a) (filed claim is deemed allowed unless objected to); Fed. R.
Bankr. P. 3001(f) and 3002(a);In re Hudson Oil Co., 91 B.R. 932, 945 (Bankr. D.
Kan. 1988); In re Coleman American Companies, Inc., 26 B.R. 825, 830 (Bankr. D.
10 In re Hudson Oil Co., supra at 945; In re Broadband Wireless Intern. Corp.,
295 B.R. 140, 145 (10th Cir. BAP 2003); In re Harrison, 987 F.2d 677, 680 (10th Cir.
11 Hudson Oil Co., supra; In re Broadband Wireless Intern. Corp., supra.
12 See § 1225(a)(1) (In order for plan to be confirmed, it must comply with theprovisions of chapter 12); In re Ames, 973 F.2d 849, 851(10th Cir. 1992) (Chapter 12debtors bear burden of establishing all elements necessary for confirmation ofplan.).
13 The corrected stipulations are contained in Dkt. 81.
14 The 2009 tax return and accompanying tax schedules are attached as anexhibit to the original stipulations, Dkt. 80-1.
Case 10-12997 Doc# 95 Filed 07/08/13 Page 5 of 27
unsecured claim and to pay it with the monthly disposable income from their non-
farming jobs. The debtors were not reorganizing their farming operation, having sold
most, if not all, of their non-exempt real and personal property prepetition.15 The IRS
filed the only objection to the chapter 12 plan.16 It filed a proof of claim on September
20, 2010, asserting a priority claim in the amount of $301,574.68 ($297,081 tax and
$4,493.68 interest to petition date) and an unsecured nonpriority claim in the amount
of $7,438.42 for a total claim of $309,013.10.17 The IRS assessed the 2009 tax on
August 16, 2010.18
Prior to their filing, the debtors were engaged in a “farming operation” within
the meaning of 11 U.S.C. § 101(21). In their 2009 tax return, debtors reported income
from three components that are relevant here:
(1)long-term capital gains of $230,533 [Line 13, Form 1040 (derived from
Schedule D - capital gains and losses and Form 4797, Part I)];
(2) ordinary gains in the amount of $512,197 [Line 14, Form 1040 (derived from
Form 4797, Part II and III - sales of business property)]; and
(3) net farming profit of $283,662 [Line 18, Form 1040 (derived from Schedule
F – profit or loss from farming)].19
15 Dkt. 10. Debtors had no secured creditors or claims. Apart from the taxdebt, debtors only had unsecured debt, including Mrs. Keith’s student loan debt.
16 Dkt. 20.
17 Proof of Claim No. 10.
19 Debtors 2009 1040 tax return and accompanying Schedules and Formswere stipulated into evidence and may be found at Dkt. 80-1.
Case 10-12997 Doc# 95 Filed 07/08/13 Page 6 of 27
The parties stipulate that the gains reported on Line 13 and 14 of Form 1040 were the
result of prepetition sales of farm assets used in the farming operation and that the tax
on that gain should be stripped of its priority under § 1222(a)(2)(A) and treated as an
unsecured claim.20 The gain on Line 13 resulted from the sale of land and a swather.
The gain on Line 14 is attributed to the sale of breeding livestock, equipment, a shed,
The IRS contends that the tax on the $283,662 net farm profit reported on Line
18 is not entitled to § 1222(a)(2)(A)’s favorable treatment. Line 18 income is “Farm
income or (loss)” derived from Schedule F. The debtors’ farm income reported on
Schedule F came from three sources: the sale of feeder cattle, grain, and other
products they raised, including alfalfa, corn, and sunflowers for $355,179 [Line 4],
agricultural program payments of $14,597 [Line 6a], and crop insurance proceeds of
$80,764 [Line 8a].21
The parties stipulate that the total farming expenses on Schedule F should all
be subtracted from the Line 4 sales income and that this income stemmed from the
“[s]ales of livestock, produce, grains, and other products you raised.”22 The question is
whether the tax on this Schedule F income “arises as a result of the sale, transfer,
20 Dkt. 81, p. 3, ¶ 9.
21 Dkt. 80-1, p. 12, Sched. F, Lines 4, 6a, and 8a.
22 Id., Line 4. See also Dkt. 81, p. 4, ¶s 12-13 (All of these products were held less than
Case 10-12997 Doc# 95 Filed 07/08/13 Page 7 of 27
exchange, or other disposition of any farm asset used in the debtor’s farming operation”
as § 1222(a)(A) provides.23
The parties stipulated to various calculations of the debtors’ priority tax liability
under both the proportional and marginal allocation methods.24 These calculations are
as follows. The IRS applied the proportional method by determining the percentage of
gross income attributable to the gain income reported on Form 1040, Lines 13 and 14
and the percentage of gross income attributable to all other income on Form 1040,
including Line 18 (Schedule F, net farm income). Concluding that 71% of their gross
income was attributable to Lines 13 and 14 while 29% of their gross income was
attributable to all other sources of income, the government multiplied the total tax due
on Form 1040, Line 55, $278,632, by .29 to arrive at the amount of the tax attributable
to non-gain, ordinary income, $80,803. Then it added the debtors’ self-employment tax
of $19,287 and deducted the amount of $838 for tax payments, yielding a priority tax
claim of $99,252.25 The remainder of the IRS’s tax claim ($278,632- $99,252=$179,380)
is attributable to the Line 13 and 14 gains from sale of farm assets used in the farming
operation. That amount is stripped of priority and should be treated as an unsecured
claim under § 1222(a)(2)(A). Any part of this unsecured tax debt remaining unpaid at
the end of the plan term is discharged.
23 11 U.S.C. § 1222(a)(2)(A).
24 Dkt. 81, ¶s 15-17.
25 Dkt. 81, ¶ 15.
Case 10-12997 Doc# 95 Filed 07/08/13 Page 8 of 27
The debtors applied the marginal method and performed two calculations. The
first assumed that the tax on the Form 1040, Line 13 and 14 gains as well as the
Schedule F, Line 4 income of $355,179 from the sale of livestock and crops raised by
debtors would receive favorable treatment under § 1222(a)(2)(A) and be treated as an
unsecured claim. The second calculated the priority portion of the tax claim by
determining the tax on all remaining sources of income pro forma, allowing deductions
from adjusted gross income for the standard deduction and personal exemption to
arrive at taxable income of $85,095. The tax on this amount together with the
recalculated self employment tax, less tax prepayments, yields a priority tax claim of
$26,433.26 The balance of the tax debt is unsecured and subject to discharge if not paid
in full upon completion of the plan.
The debtors’ alternative marginal calculation assumes that the tax on the gains
from Form 1040, Lines 13 and 14, Schedule F, Line 4 income, and Schedule F, Line 8b
crop insurance proceeds of $80,764 would be treated as unsecured claims under §
1222(a)(2)(A). The remaining sources of income less the standard deduction and
personal exemption equals a taxable income figure of $10,037. The tax on this figure
plus the recalculated self employment tax and less tax payments yields a priority tax
claim of $2,380.27 The balance of the tax debt would be an unsecured claim and subject
26 Dkt. 81, ¶ 16.
27 Dkt. 81, ¶ 17.
Case 10-12997 Doc# 95 Filed 07/08/13 Page 9 of 27
The stipulations do not include a marginal allocation calculation of the amount
of the priority tax claim assuming that only the tax on Form 1040, Lines 13 and 14,
gains would receive the § 1222(a)(2)(A) treatment.
With the facts that control this matter established, we turn to the meaning of
the statutory language of § 1222(a)(2)(A) to determine whether the tax attributable to
the Schedule F income should be excluded from the priority tax calculation. If that
portion of the tax should be treated as a priority claim, we then must consider which
is the appropriate method for determining how much of the Government’s claim should
be accorded that priority.
A. Hall v. United States and Section 1222(a)(2)(A)
Section 1222(a)(2)(A) states:
(a) The plan shall–
(2) provide for the full payment, in deferred cash payments, of all
claims entitled to priority under section 507, unless-(
A) the claim is a claim owed to a governmental unit that
arises as a result of the sale, transfer, exchange, or other
disposition of any farm asset used in the debtor's farming
operation, in which case the claim shall be treated as an
unsecured claim that is not entitled to priority under section
507, but the debt shall be treated in such manner only if the
debtor receives a discharge; or
(B) the holder of a particular claim agrees to a different
treatment of that claim;28
28 11 U.S.C. § 1222(a)(2)(A) (Emphasis added).
Case 10-12997 Doc# 95 Filed 07/08/13 Page 10 of 27
Thus, chapter 12 debtors are granted some level of relief from taxes that are incurred
on gains generated by the voluntary or involuntary disposition of their farm-related
assets. Shortly after this section took effect, litigation about the scope of this relief
arose. The most-often litigated issue was whether this relief applied to gains taxes that
were generated postpetition. After different Courts of Appeal reached different results,
the Supreme Court granted certiorari in Hall v. U.S. and resolved that issue in favor
of the taxing authorities, holding that only the taxes generated by prepetition
dispositions of farm assets could be accorded this preferential treatment.29
Hall resolved a split among the Eighth, Ninth, and Tenth Circuits on whether
the income tax arising from the postpetition sale of farm assets could be stripped of its
priority under § 1222(a)(2)(A).30 Those Circuit cases were Knudsen, Dawes, and Hall.31
Unlike the current case, all of these cases involved tax claims arising from the
postpetition sale of farm assets. Under § 1222(a)(2) priority claims under § 507 must
29 Hall v. United States, ___ U.S.___, 132 S. Ct. 1882, 182 L.Ed 2d 840 (2012).
30 132 S. Ct. at 1886, n. 1.
31 Knudsen v. IRS, 581 F.3d 696 (8th Cir. 2009) (taxes arising frompostpetition sale of farm assets could be stripped of priority status under the §
1222(a)(2)(A) exception and discharged), abrogated by Hall v. United States, 132 S.
Ct. 1882 (2012); United States v. Dawes, 652 F.3d 1236 (10th Cir. 2011) (postpetitionincome taxes incurred from sale of a farm asset during chapter 12 proceeding werenot dischargeable and were not eligible for treatment as unsecured claims under §
1222(a)(2)(A)); and United States v. Hall, 617 F.3d 1161 (9th Cir. 2010) (taxes arisingfrom postpetition sale of farm assets are not priority claims and ineligible for the §
1222(a)(2)(A) exception). While Dawes was pending in the Tenth Circuit Court ofAppeals, the same legal issue was decided by the Bankruptcy Appellate Panel in
IRS v. Ficken, 430 B.R. 663 (10th Cir. BAP 2010). Ficken was also appealed to theTenth Circuit and after that court decided Dawes on June 21, 2011, it also reversed
the bankruptcy court’s judgment in Ficken, see In re Ficken, 2011 WL 3663727, 433
Fed. Appx. 682 (10th Cir. Aug. 23, 2011).
Case 10-12997 Doc# 95 Filed 07/08/13 Page 11 of 27
be paid in full unless the claim meets the criteria of § 1222(a)(2)(A), in which event the
priority claim may be treated as an unsecured claim and discharged without being paid
in full. In Hall the Supreme Court noted that postpetition claims could be § 503(b)
administrative tax claims that are granted priority under § 507(a)(2) or prepetition tax
claims under § 507(a)(8).32 Hall turned on the question of whether the tax was
“incurred by the estate” within the language of § 503(b) as required for a § 507(a)(2)
priority claim. Because there is no separate taxable estate in a chapter 12 bankruptcy,
the estate incurs no tax in a postpetition sale of farm assets and there is no priority tax
claim that is subject to § 1222(a)(2)(A). Unlike Hall, our case involves a prepetition
sale of farm assets and tax claim; there is no dispute here that the 2009 tax claim is
a priority claim under § 507(a)(8) unless the § 1222(a)(2)(A) exception applies and
permits debtors to treat it as an unsecured, dischargeable claim. Key to the Hall
decision was the language of § 503(b)(1)(B); Hall did not interpret § 1222(a)(2)(A)’s
“farm asset used in the debtor’s farming operation” language that is central to
resolution of the case at bar. Nor did Hall address the appropriate method for
calculating the tax liability. To the extent the courts in Hall, Ficken, and Knudsen
addressed these issues, the Supreme Court’s opinion in Hall arguably did not abrogate
those conclusions and they have at least persuasive authority here.
The Income from Feeder Cattle and Crop Sales Does not
Qualify for § 1222(a)(2)(A) Treatment
32 132 S. Ct. at 1885-86.
Case 10-12997 Doc# 95 Filed 07/08/13 Page 12 of 27
There is no dispute in this case that the real and personal property sold
prepetition by these debtors were “farm assets.”33 But that alone does not qualify the
tax on the proceeds of those sales for treatment under § 1222(a)(2)(A). The assets must
be “used in the debtor’s farming operation.” The words “farming operation” are defined
in the Code as –
farming, tillage of the soil, dairy farming, ranching, production or raising
of crops, poultry, or livestock, and production of poultry or livestock
products in an unmanufactured state.34
“Used in” is not defined in the Code. Certainly the cattle and crops sold and raised in
2009 were “farm assets,” but whether they were“used in” the farming operation is less
Absent a specific definition, the principles of statutory interpretation require me
to give the words “used in” its ordinary or commonly understood meaning.35 Courts can
33 In its most basic and broadest terms, an “asset” is “[a]n item that is ownedand has value,” and consists of “entries on a balance sheet showing the items ofproperty owned, including cash, inventory, equipment, real estate, accountsreceivable, and goodwill.” See BLACK’S LAW DICTIONARY (9th ed. 2009). No
distinction is made in subpart (A) of the type of asset other than the descriptor“farm.” No further refinement of the asset as a capital or fixed asset, a current orliquid asset, or tangible or intangible asset is made. See In re Hemann, 2013 WL
1385404 at *14 (Bankr. N.D. Iowa Apr. 3, 2013) (noting “any farm asset” is “allencompassing and broadly defined,” debtor’s 50% interest in farm partnership wasa farm asset used in his farming operation.).
34 Section 101(21).
35 Hamilton v. Lanning, __ U.S. __, 130 S.Ct. 2464, 2471 (2010) (givingordinary meaning to the word “projected” in undefined phrase “projected disposableincome”); Dalton v. I.R.S., 77 F.3d 1297, 1299 (10th Cir. 1996) (interpreting §
523(a)(1)(C) discharge exception language “willfully attempted in any manner toevade or defeat such tax” as including concealment of assets to protect them fromexecution or attachment).
Case 10-12997 Doc# 95 Filed 07/08/13 Page 13 of 27
resort to dictionary definitions for guidance in ascertaining the ordinary meaning of
an undefined statutory term.36 If that term as used in subpart (A) is unambiguous,
there is no need to resort to legislative history or other rules of statutory construction.37
Statutory language is ambiguous when (1) the words have more than one meaning; (2)
the words are terms of art, having an unusual use of otherwise unambiguous words;
or (3) the purpose, intent or object of the statute cannot be ascertained from the words
used.38 Any ambiguity must appear on the face of the statute.39 As interpreted in this
case, § 1222(a)(2)(A) is not ambiguous.
Feeder cattle and crops raised by debtor are not
“used in” the operation.
Feeder cattle and crops are not “used in” a farming operation in the way that
breeding stock, land, and equipment are. The dictionary definition of “used” is
“employed in accomplishing something.”40 The verb “use” means “to put into action or
36 In re Gentry, 463 B.R. 526, 528 (Bankr. D. Colo 2011).
37 In re Smith, 447 B.R. 435, 446-47 (Bankr. W.D. Pa. 2011) (questioning
Knudsen and Hall courts’ adherence to the plain meaning rule of statutoryinterpretation; absent ambiguous statutory language, the court should not considerstatutory purpose or legislative history citing In re Phila. Newspapers, L.L.C., 599
F.3d 298, 304 (3d Cir. 2010)); Dalton v. I.R.S., 77 F.3d at 1299 (If unambiguousstatutory language is not defined, court gives language its common meaning,
provided that result is not absurd or contrary to legislative purpose.); Parks v.
Anderson, 406 B.R. 79, 93 (D. Kan. 2009) (If unambiguous, the court must interpretthe statutory language according to its plain meaning.).
38 Zeigler Engineering Sales, Inc. v. Cozad (In re Cozad), 208 B.R. 495, 498
(10th Cir. BAP 1997) (a “lien” includes consensual and judgment liens), citing Kenan
v. Fort Worth Pipe Co. (In re George Rodman, Inc.), 792 F.2d 125, 128 n. 8 (10th Cir.
40 Merriam-Webster Dictionary Online, www.merriamwebster.
com/dictionary/used?show=0&t=1370277726, June 5, 2013.
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service” and is synonymous with apply, employ, and utilize, which mean to “put into
service especially to attain an end.41 To “use” an asset to achieve an end in one’s
farming operation means something narrower than to simply show that an asset is
related or associated with a farming operation, as can be demonstrated with virtually
any farm asset. Reading § 1222(a)(2)(A) to mean that an end product of farming or
ranching, such as the harvested crops or the livestock raised, is a farm asset “used” in
the debtor’s farming operation is unnatural. It gives no meaning to the word “used.”
Black’s defines “farm products” as crops and livestock produced in farming or products
of crops or livestock in their unmanufactured state.42 Part of the definition of a
“farming operation” is the “production or raising of crops, poultry, or livestock [i.e. farm
products], and production of poultry or livestock products in an unmanufactured state.”
Does one “use” farm products such as harvested crops and raised livestock to raise or
produce farm products? Can we logically say that feeder cattle not maintained for
breeding are assets “[employed] in the debtor’s [ranching] or [raising of . . . livestock]?”
Likewise, does it make sense to suggest that the crops the debtors raised in the 2009
tax year were assets they “[employed] in the [production or raising of crops]?”
A farmer feeding livestock and raising crops does not “use” the cows or crops
that are raised; they are, instead, the fruits of the farmer’s work. The more natural
reading is that farm assets used in the production of crops or livestock are not the end
41 Id. at www.merriam-webster.com/dictionary/use?show=1373301879, July 5,2013. See also, The American Heritage Dictionary Online,
www.ahdictionary.com/word/search.html?q=use, July 5, 2013.
42 BLACK’S LAW DICTIONARY (9th ed. 2009), farm products.
Case 10-12997 Doc# 95 Filed 07/08/13 Page 15 of 27
farm products themselves.43 This is best illustrated by substituting a description of the
particular assets sold for the words “farm assets” and inserting § 101's definition of
“farming operation” into § 1222(a)(2)(A):
. . . the claim is a claim owed to a governmental unit that arises as aresult of the sale, transfer, exchange, or other disposition of [feeder cattle]
used in the debtor’s [raising of livestock or production of livestockproducts in an unmanufactured state],
Likewise, in the case of the crops:
. . . the claim is a claim owed to a governmental unit that arises as a
result of the sale, transfer, exchange, or other disposition of [corn, wheat,
sunflowers, or alfalfa] used in the debtor’s [production or raising of crops].
If every farm asset, including end products, is “used in” a farming operation,
every sale or disposition of farm assets would receive § 1222(a)(2)(A)’s favored
treatment. It seems unlikely that Congress would have chosen the “used in” language
if it meant that the government’s claim resulting from any sale of any property related
or associated with a farming operation (including the end farm product) would be
eligible for unsecured treatment, essentially granting chapter 12 debtors an income tax
holiday for the prior year’s taxes. Under this broad interpretation, the § 1222(a)(2)(A)
exception would swallow the rule for § 507(a)(8) priority claims in many chapter 12
But two courts support the debtor’s view. In Knudsen, a divided Eighth Circuit
panel concluded that farm assets include any assets associated with the farm, holding
43 See In re Knudsen, 581 F.3d 696, 721 (8th Cir. 2009), Colloton, J.,
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in that case that slaughter hogs were farm assets that were part of the debtors’
farming operation, which included the production of livestock. Thus, “farm assets”
would include “any asset related to farming operations, whether or not actually used
in farming operations.”44 “Farm assets” would therefore include what the opinion calls
“capital assets under I.R.C. § 1231, other property that may receive favorable tax
treatment . . . , and inventory items that would otherwise generate ordinary income
under I.R.C. § 61.”45 The panel majority also pointed out that “used in” must connote
the notion that the verb “use” does in § 363(c)(1) which authorizes the trustee to use
the property of the estate in the ordinary course of business. All property that can be
used, including inventory or other property held for sale (subject, of course, to the
conditions and constraints of § § 363 and 364), would be property “used in” the
operation. Under the majority’s analysis, the I.R.C.’s § 1231 capital gains provision is
of little avail in interpreting the Bankruptcy Code for three reasons. First, if a debtor
can’t “use” farm products held for resale under § 1222, the debtor can’t use “inventory”
under § 363. Second, because§ 1222(a)(2) applies to claims owed to any governmental
unit, not just the IRS, courts should not read the Internal Revenue Code’s meaning
into the bankruptcy code. Third, “to use” means “to apply or employ” and bred or raised
livestock (but not necessarily crops) are “applied or employed” in farming.
44 Knudsen, 581 F.3d 696, 712 (quoting the McQueen and Williams treatise,
Tax Aspects of Bankruptcy Law and Practice).
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In In re Ficken, the Tenth Circuit Bankruptcy Appellate Panel adopted the
Knudsen majority’s reasoning on this point and held that the sale of debtor’s calf
inventory was the sale of a farm asset used in the debtor’s farming operation. The
Knudsen majority relied on a bankruptcy tax treatise, Tax Aspects of Bankruptcy Law
and Practice, in which the authors caution against “rushing to the IRC, a body of law
that seeks bilateral determinations between the government and a taxpayer, in order
to understand provisions in the Bankruptcy Code, a body of law that seeks to resolve
multilateral claims and rights in a context far different with far different policies than
one would find under the IRC.”46 Like the Eighth Circuit, the Ficken panel looked to
bankruptcy law rather than tax law to determine what these words mean in §
The dissenting judge in Knudsen skillfully articulated the better view that §
1222(a)(2)(A)’s protection does not extend to the tax on farm income. In that case, the
debtors raised hogs for slaughter. The dissenting judge applied § 1222(a)(2)(A) this
They [debtors] raised livestock and sold them for slaughter. The
slaughter hogs, therefore, were assets produced by the farming operation,
not assets used in the livestock-raising operation. . . . The statute refersto claims arising as a result of the sale of an asset that was already usedin the farming operation. The sale itself cannot be the use. With respect,
the majority’s analysis, adopted largely from a treatise on bankruptcypractice, overlooks this textual requirement.47
46 Ficken, 430 B.R. 663, 673, quoting C. Richard McQueen & Jack Williams,
TAX ASPECTS OF BANKRUPTCY LAW AND PRACTICE, 3d ed. at § 14:9.
47 581 F.3d at 721.
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Nor did the dissent hesitate to consider the tax law in ascertaining § 1222(a)(2)(A)’s
. . . I see no flaw in the bankruptcy court consideration of § 1222(a)(2)(A)
in pari materia with the capital gains provision of 26 U.S.C. § 1231(b),
which indicates that beneficial capital-gain tax treatment is limited tobreeding livestock. The Knudsens and the majority acknowledge, evenhighlight, that a principal purpose of § 1222(a)(2)(A) was to address thetreatment of a debtor’s capital gains taxes. In that context, the analysisof § 1222(a)(2)(A) is better informed by the closely related provision of theInternal Revenue Code than by a provision of the bankruptcy code, 11
U.S.C. § 363, that operates in a different context and has no relation totax claims (or any other claims of governmental units) arising from thesale of assets.48
Common sense suggests that “assets used in . . . [a] farming operation” are more
akin to capital assets than those assets the debtors produce and hold for sale to end
customers in the ordinary course of their business. The tax on the income generated
by the sale of those assets should not be protected by § 1222(a)(2)(A) from priority
treatment. While the language of § 1222(a)(2)(A) does not expressly refer to capital
assets, Congress’s use of the phrase “used in the debtor’s farming operation” suggests
that only the tax on the proceeds of sales of capital or working assets are eligible for
1222(a)(2)(A) treatment. This approach is consistent with the Internal Revenue Code’s
favorable tax treatment on the sale of property used in the trade or business and is
what Collier’s presumes to be the proper interpretation of § 1222(a)(2)(A).49 And, while
48 Id. at 721-22.
49 See Alan N. Resnick and Henry J. Sommer, 8 COLLIER ON BANKRUPTCY ¶
1222.02 (16th ed. 2012) (Intent of § 1222(a)(2)(A) stripping provision was to“render capital gains taxes on disposition of farm assets into general unsecuredclaims” for farmers’ chapter 12 plan treatment.)
Case 10-12997 Doc# 95 Filed 07/08/13 Page 19 of 27
McQueen and Williams correctly suggest that the aims of the tax law differ from those
of the bankruptcy code, there is no reason why courts should not consider tax law in
interpreting that part of the bankruptcy code that specifically deals with priority tax
The Internal Revenue Code carefully distinguishes between capital and other
assets. Section 1221 of the Internal Revenue Code defines “capital” assets.50 Excluded
from the definition is property held for sale, real property used in a trade or business,
and property held subject to depreciation.51 But among the “special rules for
determining capital gain” is I.R.C. § 1231(b)(1) which grants favorable tax treatment
to various farm assets, including property “used in trade or business” that is subject
to depreciation and held for more than one year, and real estate “used in the trade or
business” that is held for more than one year, but excluding inventory or property held
for sale to customers in the ordinary course of business.52 It also includes livestock and,
in particular, cattle and horses that are held for “draft, breeding, dairy, or sporting
purposes” for more than 24 months.53 Only unharvested crops are considered when the
land on which they are growing and which is used in the trade or business is sold.54
50 26 U.S.C. § 1221.
51 IRC § 1221(a)(1) and (2). It also excludes supplies regularly used orconsumed in the taxpayer’s trade or business. § 1221(a)(8). Gains from the sale of
capital assets are further broken down into short-term and long-term capital gainsdepending on the length of time the asset is held. See § 1222(1) and (3).
52 IRC § 1231(b)(1) and (b)(1)(A) and (B).
53 IRC § 1231(b)(3)(A).
54 IRC § 1231(b)(4). Presumably harvested crops are excluded from specialcapital gain treatment as inventory or property held for sale to customers under §
1231(b)(1)(A) and (B).
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When the sale of §1231 property generates gain, that gain is treated as capital gain
that is taxable at a lower rate; when those sales result in loss, that loss reduces
ordinary income, which is usually taxed at a higher rate.55
The gains the Keiths reported on lines 13 and 14 of their return were the
proceeds of sales of land and buildings, breeding stock, and equipment used in their
farming operation. Those gains are reported on Form 4797 – sales of property used in
a trade or business (§ 1231 property on Part I, Form 4797) and gains from the sale of
certain depreciable I.R.C. § 1245 property (§ 1245 property on Part III, Form 4797).56
By contrast, the income on their tax return from the sale of feeder cattle they raised
were not “gains.” Instead, the Keiths reported that income as ordinary farm income on
Schedule F. They reported their crop income in the same fashion. Line 4 of Schedule
F requests revenue from “sales of livestock, produce, grains, and other products you
raised,” not revenue from sales of farm products “used” in the farming operation.
Indeed, the Part I instructions on Schedule F specify: “Do not include sales of livestock
held for draft, breeding, sport, or dairy purposes. Report these sales on Form 4797.”57
Certainly none of the assets whose sale generated the farm revenue shown on Schedule
F and Line 18 of Form 1040 are capital assets, either. The Internal Revenue Code
distinguishes between assets “used in a trade or business” and those that are held for
55 IRC § 1231(a)(2).
56 Dkt. 80-1, pp. 15-16. IRC § 1245(a)(3)(A) - (F) specifically defines whatdepreciable property constitutes “§ 1245 property.”
57 Dkt. 80-1, p. 12.
Case 10-12997 Doc# 95 Filed 07/08/13 Page 21 of 27
sale to customers. There is no reason to construe the words “used in” one way in I.R.C.
§ 1231(b) and another way in Bankruptcy Code § 1222(a)(2)(A).
Nor does § 363's authorizing the trustee to “use, sell or lease property of the
estate” in and outside the ordinary course of debtors’ business or to “use cash
collateral” affect the interpretation of the word “used” in § 1222. Section 363 generally
applies to every remedial chapter. It does not address allowing the claims of a
governmental unit or to treating those claims under a plan. Rather, § 363 governs the
trustee’s use or other disposition of property of the estate and defines when court
authority is required to do that.58
The income tax generated by the debtors’ ordinary farm income (Form 1040,
Line 18) did not result from a sale of “farm assets used in the farming operation” and
should be treated as a priority claim, not an unsecured claim under § 1222(a)(2)(A).
2. Crop insurance proceeds are not “used in” the operation.
Line 8 of Schedule F requests “crop insurance proceeds and federal crop disaster
payments.” That income is similar to ordinary income from the sale of farm products
raised by debtors because it compensated the debtors for a failed crop. The Keiths
reported $80,764 in farm income from crop insurance. No court has addressed whether
the tax generated by crop insurance proceeds should receive §1222(a)(2)(A) treatment.
Like crops, crop insurance proceeds are “farm assets,” but nothing in the stipulations
58 If any part of the Bankruptcy Code would guide the Court’s interpretationof § 1222, it would be provisions from chapter 13, upon which chapter 12 wasmodeled. But the exception to full payment of certain priority tax claims added in §
1222(a)(2)(A) by BAPCPA is not present in the chapter 13 counterpart, § 1322(a)(2).
Case 10-12997 Doc# 95 Filed 07/08/13 Page 22 of 27
suggests that the Keiths used these insurance proceeds in their farming operation to
produce or raise livestock, grains, or crops. Instead, these insurance payments are the
proceeds of a failed crop and, like a successful crop, are “end results” of the debtors’
farming operation. A claim for any tax they generate is a priority claim under §
The debtors will not “use” these assets in a reorganized
In both Knudsen and Ficken, the debtors proposed to liquidate part of their
property and reorganize using the proceeds of that liquidation to support their
reorganized operation. The Keiths do not propose that. Instead, they intend to rely on
off-farm employment for their post-confirmation income.59 There is nothing in the
record to suggest how the 2009 crops or cattle raised by debtors or the crop insurance
proceeds would be “used” by the debtors in their reorganization.
None of the tax on the Schedule F income may be treated
under § 1222(a)(2)(A).
None of the tax that was generated by the debtors’ farm income reported on
Schedule F is excluded from treatment as a priority claim by § 1222(a)(2)(A). That
presents the second issue in allowing the Government’s priority and unsecured claims:
what calculation method to use in determining what portion of the IRS’s total tax claim
for 2009 “arises as a result” of the debtors’ other farm asset sales.
59 See Ficken, 430 B.R. at 674 (concluding that “farming operation” referencedin § 1222(a)(2)(A) is the farming operation of the reorganized debtor).
Case 10-12997 Doc# 95 Filed 07/08/13 Page 23 of 27
C. The marginal method better measures the priority and unsecured
claims than the proportional method.
Allowing the Government’s priority and general unsecured tax claims can be
done using either the proportional or marginal allocation method. The proportional
method advocated by the Government involves dividing the debtors’ ordinary farming
income by their total income and multiplying the Government’s total tax claim by the
fraction that results. That result, in turn, is subtracted from the Government’s total
claim and the remainder is the unsecured claim eligible for treatment under §
1222(a)(2)(A). The marginal method advocated by the debtors involves preparing a pro
forma tax return that omits the income from the sale of assets and subtracting the pro
forma tax from the total tax due on their actual return. The remainder would represent
the amount of tax that arose from the sale of eligible farm assets. The Knudsen and
Ficken courts considered this issue at length and adopted the marginal tax allocation
method.60 When the Supreme Court reversed the Knudsen decision and the Tenth
Circuit reversed Ficken, neither court addressed this issue. Nevertheless, the
Government, some commentators, and at least one judge suggest that proration strikes
the best balance between the farmer’s interest in successfully reorganizing and the
government’s interest in maximizing revenue, while “the marginal method, by contrast,
is a one-sided approach that tilts in favor of the debtor by disproportionately reducing
60 Knudsen, 581 F.3d at 718; Ficken, 430 B.R. 663, 678.
Case 10-12997 Doc# 95 Filed 07/08/13 Page 24 of 27
the amount of tax unrelated to the sale of farm assets that is entitled to priority
treatment.“61 I disagree.
The problem with the proportional method is that simply carving up a farmer
debtor’s tax bill into proportions by applying the ratio of the debtor’s non-sale income
(priority tax claim) to the debtor’s total income and dividing the total tax claim
accordingly ignores the impact of tax deductions and tax credits on the farmer’s
ultimate tax liability, many of which are indexed to income and phase out as it
increases.62 As the Bankruptcy Appellate Panel noted in Ficken,
Personal deductions and credits are those that are unrelated to the cost
of earning income. Generally speaking, personal expenses are notdeductible, but for policy reasons and/or based on ability to pay, Congresspermits some personal expenses, such as costs for medical care, to bededucted, and gives credits for others, such as tuition for highereducation. However, when a taxpayer's AGI reaches a certain level, he orshe is perceived as a “high income taxpayer” who should not benefit fromthese personal deductions and credits.63
Because of the graduated nature of the income tax, the proportional method
dramatically and artificially increases the debtor’s adjusted gross income and
significantly inflates the Keiths’ priority tax obligation to an amount several times that
which it would be under the marginal method. It ignores the effects of various
deductions and credits that are tied to a debtor’s income level by maximizing the
debtor’s taxable income and, in turn, minimizing the debtor’s deductions.
61 Knudsen,581 F.3d at 723 (concurring and dissenting judge).
62 Knudsen, 581 F.3d at 717-18 (noting that the proportional method treatseach dollar of income the same while the income tax is a graduated tax).
63 Ficken, 430 B.R. at 677-78.
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There is no reason to burden the debtors with this result when the effect of the
debtor’s ordinary farming income on the Keiths’ taxes can easily be measured by
preparing an actual tax return that recognizes all of their ordinary farm income as well
as gain income and comparing it to a hypothetical return that only recognizes ordinary
farm income. The difference between the two results is directly attributable to the gain
income that arose from the sale of qualifying farm assets–those used in the farming
The proportional method doesn’t measure what income “causes” which portion
of the tax claim. It is, instead, simply an approximation, one that in this case errs
heavily in the Government’s favor. While using it may strike some sort of balance
between the government’s quest to realize revenue and the debtor’s desire to lessen his
or her priority tax burden, nothing in the Bankruptcy Code requires us to strike that
balance.64 The point instead is to accurately allow the Government’s priority and
unsecured claims. Section 1222(a)(2)(A) links its relief from the priority tax treatment
to the amount of income tax caused by the sale of farm assets and courts should employ
the most accurate available means of determining the extent of that relief.
In sum, that amount of income tax that arises from all of the debtors’ income
that was realized upon the sale or disposition of their farm assets (Form 1040, Lines
13 and 14), determined using the marginal method, may be treated as a general
64 Indeed, the purpose behind this priority stripping measure was to reducethe negative tax consequences resulting from a sale of farm assets that had to bepaid in full, thereby enabling family farmers to successfully confirm plans ofreorganization. See Ficken, 430 B.R. at 675.
Case 10-12997 Doc# 95 Filed 07/08/13 Page 26 of 27
unsecured claim under § 1222(a)(2)(A). The Government’s remaining income tax claim
should be allowed and treated as a § 507(a)(8) priority tax claim that must be paid in
full under § 1222(a)(2).
Further submissions are required before the Court can determine
the allowed amounts of the IRS’s priority and unsecured claims.
While the income tax claim resulting from Line 13 and 14 income may be treated
as a general unsecured claim under § 1222(a)(2)(A), there is nothing in the stipulations
to assist me in applying the marginal method to calculate that portion of the
Governments claim. I therefore direct the parties to supplement the stipulations by
calculating the amounts of the Government’s § 1222(a)(2)(A) general unsecured and
priority tax claims in a manner consistent with this opinion, including prepetition
interest on the priority claim,65 within 28 days of its entry. If the parties are unable to
stipulate concerning those amounts, counsel should advise the Clerk accordingly so
that the matter may be set for a prompt evidentiary hearing.
# # #
65 Dkt. 81, ¶s 18-19.
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